A smart contract-based system that enables decentralized trading by using liquidity pools instead of traditional order books.
An Automated Market Maker (AMM) is a protocol that enables decentralized trading without traditional order books. Instead of matching buyers and sellers, AMMs use liquidity pools — smart contracts filled with tokens — to determine prices automatically.
AMMs transformed decentralized finance by allowing anyone to provide liquidity and earn fees, creating an open and permissionless trading environment.
How AMMs Work
At the core of an AMM is a mathematical pricing algorithm. The most common model is the constant product formula (x × y = k), used by platforms like Uniswap.
Here’s how it functions:
- Liquidity providers deposit token pairs into a pool.
- Traders swap tokens directly with the pool rather than with another user.
- Prices adjust based on supply and demand inside the pool.
- Liquidity providers earn a share of trading fees.
This design removes the need for centralized exchanges and market makers.
Advantages of AMMs
- 24/7 liquidity: Traders can swap any time without waiting for an order match.
- Open participation: Anyone can supply liquidity and earn yield.
- Transparency: Smart contracts handle pricing, settlement, and fees automatically.
- No intermediaries: No custodians or centralized entities required.
Common AMM Models
- Constant Product AMMs: Used for most spot trading (Uniswap V2).
- Stable AMMs: Optimized for low-volatility assets like stablecoins (Curve).
- Hybrid AMMs: Combine multiple algorithms for efficiency (Balancer, Uniswap V3).
Popular AMM Platforms
- Uniswap
- Curve Finance
- Balancer
- PancakeSwap
- SushiSwap
Summary
AMMs replaced traditional order book trading in DeFi by introducing liquidity pools and automated pricing. They enable instant, permissionless swaps and allow anyone to earn through liquidity provision.
