In traditional finance, liquidity measures how quickly and with how little loss of value you can convert an asset into cash: cash itself is the most liquid asset; real estate is one of the least liquid.
Liquidity in DeFi
On decentralized exchanges, "liquidity pools" are smart contracts where multiple users deposit pairs of tokens (for example ETH and USDC) to let other users swap between those assets without needing a traditional order book. In exchange, liquidity providers earn a share of the fees from every trade.
The associated risk
Providing liquidity isn't risk-free: the main one is impermanent loss, which can reduce the value of your position compared with simply holding the tokens.