Liquidity pools are the backbone of many decentralized exchanges like PancakeSwap. Users called liquidity providers (LP) add an equal value of two tokens in a pool to create a market. In exchange for providing their funds, they earn trading fees from the trades that happen in their pool, proportional to their share of the total liquidity.
Liquidity pools are a significant innovation that allows for on-chain trading without the need for an order book. As no direct counter-party is needed to execute trades, traders can get in and out of positions on token pairs that likely would be highly illiquid on order book exchanges.