Automated Market Makers (AMMs)
A type of decentralised exchange that uses mathematical formulas and liquidity pools instead of traditional order books to enable permissionless token trading on-chain.
Automated Market Makers (AMMs)
An AMM is a smart contract that holds reserves of two or more tokens in a liquidity pool and uses a mathematical formula to determine exchange rates. Instead of matching buyers and sellers through an order book, anyone can trade against the pool at any time — and anyone can provide liquidity by depositing tokens.
How They Work
The most common AMM model is the constant product formula (x × y = k), pioneered by Uniswap:
- A liquidity pool holds reserves of two tokens (e.g. ETH and USDC)
- The product of the reserves must remain constant after each trade
- Larger trades move the price more (slippage), creating a natural price curve
- Liquidity providers (LPs) deposit equal value of both tokens and earn trading fees
- Prices adjust automatically based on supply and demand
Key AMM Designs
- Uniswap v2/v3 — constant product with concentrated liquidity (v3)
- Curve — optimised for stablecoin-to-stablecoin swaps with minimal slippage
- Balancer — weighted pools supporting multiple tokens with custom ratios
- GMX — oracle-based pricing for perpetual futures trading
Why They Matter
AMMs solved the liquidity bootstrapping problem for decentralised exchanges. Before AMMs, on-chain order books were too slow and expensive. AMMs enable:
- Permissionless trading — any token can be listed by creating a pool
- Passive income — LPs earn fees proportional to their share of the pool
- Composability — other protocols can build on top of AMM liquidity
- Price discovery — on-chain prices that other protocols can reference
Risks
- Impermanent loss — LPs can lose value relative to simply holding tokens when prices diverge
- Smart contract risk — vulnerabilities in pool contracts can lead to fund loss
- MEV — miners/validators can extract value by reordering transactions (sandwich attacks)
- Low liquidity — small pools have high slippage, making large trades expensive
The Evolution
AMMs have evolved from simple constant-product pools to sophisticated financial primitives. Concentrated liquidity (Uniswap v3), dynamic fees, and oracle-integrated designs represent the maturation of on-chain market making — increasingly competitive with centralised exchange liquidity.