Overview
An automated market maker, or AMM, is a decentralized trading protocol that uses mathematical formulas to price assets instead of a traditional order book. By maintaining a pool of two or more assets, an AMM can offer liquidity continuously: the price of a swap is derived from the current reserve ratio, so trades are always possible. AMMs made permissionless token swaps practical on Ethereum and other chains.
How It Works
The most common AMM model is the constant product formula, where the product of the two reserves stays constant. When a trader swaps one asset for another, the ratio of reserves changes and the price moves according to the formula, increasing with trade size. This means larger trades incur higher slippage, and arbitrageurs keep pool prices aligned with the broader market. Variants such as stablecoin-focused pools use specialized curves to reduce slippage for correlated assets.
Why It Matters
AMMs solved the cold-start problem of decentralized trading: there is no need to find a counterparty because the pool is always available. They also make anyone a potential market maker by depositing funds. Their design directly determines trading fees, slippage, and capital efficiency, which is why different AMM curves exist for different asset classes.
Related Concepts
AMMs operate on Liquidity Pools and power DEXs. Their pricing dynamics create opportunities for MEV extraction, and stablecoin curves like those used by Curve minimize Impermanent Loss for similar assets.