DeFi
What Is an AMM (Automated Market Maker)?
An AMM (automated market maker) is the mechanism behind most decentralized exchanges. Instead of matching buyers and sellers through an order book, an AMM prices trades algorithmically against pools of tokens supplied by liquidity providers. A mathematical formula sets the price based on the ratio of assets in the pool, so anyone can trade at any time without a counterparty, and liquidity providers earn a share of the trading fees.
How an AMM works
Liquidity providers deposit pairs of tokens into a pool. A pricing formula — most commonly the constant product formula x·y=k — determines the exchange rate from the pool's balances. As people trade, the balances shift and the price moves accordingly.
Because the pool always quotes a price, users can trade instantly against it rather than waiting for a matching order, and the AMM adjusts prices automatically as supply and demand change.
Liquidity pools and providers
Liquidity providers (LPs) earn a portion of trading fees proportional to their share of the pool. They also take on risks such as impermanent loss — the difference in value versus simply holding the tokens — when prices move significantly.
Why AMMs matter
AMMs made decentralized trading practical by removing the need for traditional market makers and order books. They power a large share of DeFi trading and let any token gain liquidity permissionlessly.
Frequently asked questions
What is an AMM?
An AMM (automated market maker) is a decentralized exchange mechanism that prices trades using a formula and liquidity pools instead of an order book, so users can trade without a direct counterparty.
How does an AMM set prices?
It uses a formula (commonly the constant product formula x·y=k) that sets the price from the ratio of tokens in the liquidity pool; trades shift the balances and move the price.
What is a liquidity pool?
A liquidity pool is a smart-contract reserve of two or more tokens supplied by liquidity providers, against which an AMM prices and settles trades.
What is impermanent loss?
Impermanent loss is the difference in value a liquidity provider experiences versus simply holding the tokens, which occurs when the pooled assets' prices diverge.
How Bitara can help
Bitara is a Web3 infrastructure and financial ecosystem builder that designs and builds the systems described above — across engineering, digital assets, and compliance. Explore the related services and topics below.
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