An Automated Market Maker (AMM) is a type of decentralised exchange protocol that uses mathematical formulas and liquidity pools rather than traditional order books to determine prices and execute trades. Instead of matching a buyer with a seller, AMMs allow traders to swap against a liquidity pool – a smart contract holding reserves of two or more tokens. The most common formula is the constant product: x times y equals k, where x and y are reserve quantities and k is a constant. When a trader buys token A with token B, the pool ratio changes, automatically adjusting the price. Uniswap popularised this model in 2018; today AMMs power the majority of DeFi trading volume. AMM innovations include Curve StableSwap (optimised for pegged assets), Uniswap v3 concentrated liquidity (LPs choose price ranges), Balancer weighted pools (multiple assets with custom weightings), and CLMMs used by Raydium on Solana. AMMs earn fees (typically 0.01-1%) on every swap, distributed to liquidity providers. Key limitation: AMMs suffer from impermanent loss for LPs and can provide worse prices than order books for large trades due to slippage.
Example: Example: On Uniswap, the ETH/USDC pool holds $50M of each. A whale swaps $5M USDC for ETH. The pool now has $55M USDC and $45M ETH. The ratio shift means ETH price in the pool increased by ~11%, and the whale experiences ~5.5% slippage on the large trade. Smaller trades experience far less slippage on the same pool.
Learn more: Uniswap Whitepaper
