Every time you swap tokens on a DEX, you’re using an automated market maker, even if you didn’t know it. AMMs exist to keep the market liquid 24/7, no buyers or sellers needed. These smart contracts always offer a price, no matter what’s happening in the market. In this guide, you’ll learn what AMMs are, how they work, and how they’ve replaced human traders with code, forever.
What Is an Automated Market Maker?
An automated market maker (AMM) is a type of crypto exchange that uses smart contracts and math, not people, to set prices. Instead of matching buyers and sellers, AMMs work by letting you trade against a pool of tokens. The AMM sets the price using a formula based on how much of each token is in the pool. This setup means you can swap anytime, with no waiting and no middleman.
Why Do AMMs Exist?
Markets need liquidity—someone who’s always ready to buy or sell. On centralized exchanges, that role belongs to professional market makers. But in DeFi, there are no desks, no brokers, and no guarantees.
AMMs were built to solve this problem. They use smart contracts to provide constant liquidity, even when no one else is around to trade.
You don’t need an order book, a counterparty, or permission to use them. Just a crypto wallet.
By automating the market maker role, AMMs made decentralized finance actually usable, and globally accessible to anyone, anytime, without centralized intermediaries.
Where Are AMMs Used?
AMMs power most decentralized exchanges today. When users trade tokens on platforms like Uniswap or PancakeSwap, they’re using an AMM. These systems handle billions in volume, making them a core part of DeFi.
They’re used to exchange all kinds of crypto assets, from major coins like ETH and USDC to new tokens that aren’t listed on other exchanges yet.
You’ll also find AMMs in crypto wallets, aggregators, and cross-chain bridges. They run in the background, enabling smooth, fast swaps, all without ever needing an order book or centralized control.
Traditional Market Makers vs. AMMs
In a traditional market, a market maker is a company or trader that constantly buys and sells assets to keep prices stable. These makers sit between buyers and sellers, using a traditional order book to match trades. It’s manual, permissioned, and relies on centralized intermediaries like banks or brokers.
AMMs flip that model. They use smart contracts to create open, automated liquidity pools. Instead of matching orders, AMMs let users trade against the pool itself.
In traditional finance, access often depends on your location, identity, or account size. AMMs connect directly to your wallet and are —available 24/7, no questions asked.
They’re not tied to external markets either. They’re native to blockchain, built for permissionless access.
How AMMs Work
AMMs run on smart contracts—bits of code stored on blockchain technology. These contracts manage liquidity pools: shared reserves of two tokens that users trade against.
When you swap tokens, you’re not trading with another person. You’re trading with the AMM pool. It holds an asset pair, like ETH and USDC. Your trade affects the pool’s balance and price.
Most AMMs use the constant product formula:
x × y = k
Here, x and y are the amounts of each token in the pool. k stays constant. So if you add ETH (x), the pool gives you USDC (y), and the formula adjusts the price automatically.
This mathematical formula creates a pricing curve. The more you take out of one asset, the more expensive it gets. That’s how the AMM protects the pool’s assets from being drained.
The relative price—or exchange rate—is based on the current token ratio. This determines the market price you’ll pay. The pool doesn’t know what price other exchanges offer. Instead, it relies on its own balance to set the rate.
Because of this system, there’s always liquidity—but the supply you get may change depending on how big your trade is. Bigger swaps move the price more. That’s why smaller trades get better rates in AMMs.
Types of AMM Models
AMMs aren’t one-size-fits-all. Over time, developers have built different models to serve different needs. Let’s break down the three most common types.
Constant Product Market Makers (e.g., Uniswap)
This is the most popular model, used by Uniswap and many others. It’s based on the constant product formula (x × y = k) we covered above.
These are known as constant product market makers. They work well for volatile asset pairs, like ETH and USDC. Prices shift based on supply, not external quotes.
As traders buy one token, the pool gives out less of the other, increasing its price. It’s simple, efficient, and widely used across Ethereum and EVM-compatible chains.
Stablecoin-Focused AMMs (e.g., Curve Finance)
Swapping stablecoins (like USDC and DAI) needs low slippage. That’s where stablecoin-focused AMMs like Curve come in.
Instead of constant product math, Curve uses a hybrid formula that flattens the curve around the $1 price point. This allows large trades with minimal price movement, perfect for stablecoin swaps or wrapped tokens like wBTC.
Curve became essential to the DeFi ecosystem by offering deep, efficient liquidity for stable assets.
Multi-Asset Pools (e.g., Balancer)
Balancer introduced multi-asset pools that can hold more than two tokens with custom weightings, for example, 60% DAI, 20% ETH, 20% LINK.
These pools help users hold different assets in one place and still earn fees. They work like self-balancing index funds, where the AMM automatically rebalances to keep target ratios.
What Is a Liquidity Provider (LP)?
All AMMs need liquidity to work, and that comes from users. These users are called liquidity providers.
Anyone can provide liquidity by depositing tokens into a pool. In return, AMM liquidity providers earn a cut of trading fees.
When you add funds to a pool, the smart contract gives you LP tokens. These represent your share of the pool. You can redeem them anytime.
This kind of liquidity provision lets regular users act like market makers, which is something only big firms could do in traditional finance. It’s a core reason DeFi is open to everyone.
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Advantages of AMMs
AMMs bring powerful benefits to DeFi.
First, they offer deep liquidity that’s always available. You don’t need a buyer or seller to be online, the pool handles it by itself.
Second, AMMs lower the barrier to entry. By allowing users to trade or earn fees directly from their wallets, they open markets to anyone.
Projects also get more liquidity faster. Instead of paying to list on an exchange, they can just launch a pool.
And for liquidity providers AMMs are a chance to generate profit. You earn a share of fees every time someone trades in your pool. It’s simple, automatic income, no middlemen required.
Risks and Challenges
AMMs aren’t risk-free.
The biggest issue for LPs is impermanent loss. If token prices shift too far apart, your share of the pool may be worth less than if you held the tokens separately.
Price impact is another concern. Larger trades can shift the pool’s ratio and give you worse rates—this is known as slippage.
While trading fees help offset losses, they aren’t guaranteed to cover everything.
Other risks include smart contract bugs, front-running bots, or poorly audited protocols. Always research a pool before joining and avoid putting in more than you can afford to lose.
Understanding these trade-offs is key to using AMMs safely.
Popular AMM Platforms
- Uniswap was the first to bring AMMs to the mainstream. It runs on Ethereum and Layer 2 chains, with billions in daily volume.
- SushiSwap started as a Uniswap fork but added community rewards and multichain support.
- Curve Finance focuses on stablecoins. Its formula offers ultra-low slippage for assets like USDC, DAI, and wBTC.
- PancakeSwap is the top AMM on BNB Chain. It’s known for fast, low-fee swaps and a large token list.
- Balancer lets users create custom-weighted pools with multiple tokens.
How Can The Current AMM Model Be Improved?
Two big issues still frustrate AMM users today.
Capital inefficiency is the first. Most pools spread liquidity across all prices, so a lot of funds just sit unused. Newer models like Uniswap v3 fix this by letting LPs focus on tighter price ranges. It boosts returns, but adds risk and complexity.
High cost and poor execution is the second. Small trades often get hit with slippage, gas fees, or front-running bots. Smarter routing, dynamic fees, and built-in protection against MEV could make AMMs faster, cheaper, and fairer for everyone.
Final Words and The Future of AMMs
Despite having some drawbacks, AMMs are becoming the backbone of decentralized finance. As Layer 2 networks and modular blockchains grow, AMMs will get faster and cheaper. In the long run, AMMs will anchor lending, options, and new DeFi primitives. The next phase of crypto will likely be built around them.
Currently, notable institutional players are starting to explore on-chain trading, which could drive more liquidity. We will also see more hybrid models that blend features of AMMs and order books down the adoption path.
FAQ
Do AMMs support fiat-to-crypto trading?
Not directly. AMMs only swap crypto tokens already on the blockchain. You can’t use fiat (like USD or EUR) unless you first convert it using a fiat on-ramp, such as a centralized exchange or crypto purchase service.
Once you have crypto in your wallet, you can use an AMM to swap between tokens. Some DeFi wallets integrate both steps for a smoother experience.
Can I lose money by adding my tokens to an AMM?
Yes, you can. The biggest risk is impermanent loss, which happens when the prices of the tokens in the pool diverge too much. Even if the pool earns trading fees, they may not cover that loss.
Smart contract bugs or extreme market shifts can also put LP funds at risk. Always research the pool, use trusted protocols, and understand how liquidity works before depositing.
Are AMMs safe to use?
Mostly yes, but they’re not risk-free. AMMs are built on smart contracts, which run automatically. If the code is solid and audited, they’re usually secure. Still, no system is perfect. Hacks have happened. To stay safe, use well-known platforms like Uniswap or Curve, avoid new unaudited projects, and never trade more than you can afford to lose.
Why did I get fewer tokens than I expected in a swap?
You probably experienced slippage. AMMs adjust prices based on trade size and pool balance. If you swap a large amount or the pool has low liquidity, the price moves while your trade is processing.
Check slippage tolerance settings before confirming a swap. Also, avoid volatile tokens or thin pools if you’re making big trades.
What is the purpose of the AMM?
An AMM replaces traditional market makers with code. Its purpose is to let users trade tokens directly, 24/7, without relying on a centralized exchange. They’re a key building block of the DeFi ecosystem.
Who uses AMM?
Anyone with a crypto wallet. Traders use AMMs to swap tokens easily. Investors use them to earn fees by providing liquidity. Developers use them to bootstrap markets for new tokens.
Disclaimer: Please note that the contents of this article are not financial or investing advice. The information provided in this article is the author’s opinion only and should not be considered as offering trading or investing recommendations. We do not make any warranties about the completeness, reliability and accuracy of this information. The cryptocurrency market suffers from high volatility and occasional arbitrary movements. Any investor, trader, or regular crypto users should research multiple viewpoints and be familiar with all local regulations before committing to an investment.
