In summary, Liquidity Pools group funds from "liquidity providers" and act as the counterparty in a trade. This concept is not common in traditional finance, where the counterparty to a stock trade or a loan is a stock broker or a bank. Because DeFi is decentralized, there are no direct counterparties to these types of trades, but rather traders transact against a large number of liquidity providers grouped in a Pool (peer-to-pool model).
Each Pool is unique in DeFi as it has a specific job type (market-making, lending, option selling, etc), it operates in a specific protocol (Uniswap, Aave, Curve, etc), it holds specific assets (BTC, ETH, USDC, etc), and earns a specific fee on each trade (0.01%-1% usually).
Liquidity providers own a share of the total pool proportional to their investment. In most DeFi pools, all liquidity providers share the fees revenue, lending interest, or other earnings proportional to their share. When you invest in a pool, you become a liquidity provider.
The key metrics to pay attention to for any Pool are
Total Value Locked (TVL): the dollar value of the assets held in the pool. Larger TVL means deeper liquidity for traders, which means more trading volume, which results in higher yields, and which attracts more liquidity.
Yield: the ratio of pool revenue, pool trading fees, or lending interest divided by the amount of TVL. This number is almost always quoted in Annualized Percentage Yield, to facilitate comparisons. Read more about Yield here.
Risk Score: the relative level of risk specific to a Pool. Exponential developed a novel framework to assess DeFi risks, which are encapsulated in the Risk Grade (A/B/C/D/F). Read more about our Risk Score here.
Pools have some advantages over the traditional counterparty model. When traders look to swap asset A for asset B, they can shop around for the pool that will give them the best price or the cheapest cost because this data is freely available. Borrowers can also shop for the lending pools with the largest liquidity (and thus lower borrowing rates) or with the lowest fees.