From order books to formulas
A traditional exchange matches a buyer’s bid with a seller’s ask. That needs constant two-sided interest and fast, centralized infrastructure — a poor fit for a blockchain. An AMM sidesteps the problem entirely: liquidity providers deposit tokens into a liquidity pool, and a formula quotes a price for any trade against those reserves, at any time, with no counterparty required.
How an AMM prices a trade
The classic design is the constant-product market maker, x · y = k, used by Uniswap V2 and its forks. Price is the ratio of the two reserves, and every trade shifts that ratio — so the more you buy, the worse your rate gets. We break the maths down in how DEX prices are calculated.
Different curves for different assets
Not every AMM uses the same curve. The shape of the pricing function is tuned to what the pool holds, which is why a stablecoin pool and a volatile-pair pool behave so differently.
- Constant-product (Uniswap V2): general-purpose, works for any pair, deepest at the current price.
- Stableswap (Curve): a flatter curve that keeps near-parity assets tightly priced with low slippage.
- Concentrated liquidity (Uniswap V3/V4): LPs place liquidity in a chosen price range for far greater capital efficiency.
- Weighted pools (Balancer): more than two tokens at custom weights, acting like a self-rebalancing index.
The trade-offs LPs accept
AMMs democratised market making, but liquidity providers take on risks a passive holder does not — chiefly impermanent loss when the pool’s price ratio moves. Understanding that cost is essential before providing liquidity; see impermanent loss explained.
Frequently asked questions
What does “automated” mean in AMM?
Prices and trades are handled entirely by smart-contract code — a formula over the pool’s reserves — with no human market maker quoting bids and asks. Anyone can trade or provide liquidity permissionlessly.
Are all DEXes AMMs?
Most major DEXes are AMMs, but not all. Some use on-chain order books or hybrid designs. Uniswap, Curve, PancakeSwap, SushiSwap and Balancer — the venues CoinVerum indexes — are all AMMs.
Who sets the price on an AMM?
Nobody sets it directly. The formula derives price from the reserve ratio, and arbitrageurs keep that price aligned with the wider market by trading whenever it drifts.