In plain English
What Automated market maker means
An AMM turns a pool of tokens into a continuously available trading venue. A common model uses two reserves and keeps their product near a constant value; when someone buys one asset, that reserve declines and its price rises relative to the other asset. Different AMMs use different curves, fee rules, and liquidity arrangements.
Why it matters
An automated market maker determines the execution price, price impact, and rebalancing faced by traders and liquidity providers. It can offer onchain trading without conventional market makers, but it does not eliminate slippage, volatile prices, front-running-related risks, or smart-contract risk.
Example
Suppose a simplified pool contains 5 ETH and 10,000 USDC, so its constant-product value is 50,000. A trader adding USDC to buy ETH increases the USDC reserve and reduces the ETH reserve. Under the constant-product rule, each additional ETH purchased costs progressively more before fees because less ETH remains in the pool.
Quick answers
Common questions
Does an AMM always use the constant-product formula?+
No. The constant-product formula is a widely used model, but AMMs may use concentrated liquidity, stable-asset curves, weighted pools, auction mechanisms, or other pricing rules. The formula and parameters determine the trading and provider outcomes.
Who sets the price in an AMM?+
The smart contract calculates a quote from its reserves and rules. Traders then accept, reject, or set limits around that quote. Arbitrage trading often helps align the pool price with prices elsewhere, but alignment is neither instant nor guaranteed.
Sources