AMMs

Automated market makers (AMMs) are a type of decentralized exchange design that relies on programmable liquidity pools and pricing algorithms instead of traditional order books. In an AMM, users provide tokens to liquidity pools, and others trade against those pools. The price of each token is determined by a mathematical invariant, such as a constant product, which defines the relationship between the two tokens’ reserves in a pool.

Most AMMs operate large pools of liquidity to support swaps with relatively low slippage. Traders interact with the pool by swapping one token for another, with the pool automatically adjusting the price based on the trade size and current reserves. To incentivize liquidity provision, AMMs typically collect small fees from trades and distribute them to liquidity providers in proportion to their share of the pool.

Common models include the constant product formula x*y=k (used by Uniswap v2 and later), constant sum and other variants, and constant mean/tiered weight models found in projects like Balancer and Curve. Curve focuses on stablecoins and similarly priced assets to minimize slippage, while Balancer supports multi-asset pools with flexible weights.

Arbitrage activity helps realign on-chain prices with external markets, while impermanent loss describes the risk to LPs when relative prices diverge between deposited tokens. Other risks include smart contract bugs, front-running, and gas costs.

AMMs have become foundational in DeFi, enabling permissionless liquidity provision and token swaps across many ecosystems, and they continue to evolve with layer-1 and layer-2 deployments, improved capital efficiency, and new pricing algorithms.