What is an AMM?
- Author
- CRYPTO PORT Editorial
- Published
- Updated
- Reading time
- 5 min
In short
An AMM replaces the order book with a formula: the price comes from the ratio of two assets sitting in a pool. A trade can always execute without a matching counterparty, but a trade that is large relative to the pool moves the price sharply against you.
Key points
- Prices come from a formula, not from matched orders
- Your counterparty is the pooled capital itself
- Smaller pools mean larger price impact
- Arbitrage keeps the pool near the wider market price
Definition
A mechanism that derives an exchange rate from the quantities held in a liquidity pool using a fixed formula, settling trades without matching orders.
The most common design keeps the product of the two balances constant. With ETH and USDC in a pool, buying ETH drains ETH and adds USDC, so the next ETH costs more automatically. No one quotes the price; the formula does.
When a pool's price drifts from the wider market, arbitrageurs trade the difference and pull it back. That constant arbitrage is what lets an AMM function without an order book at all.
Newer designs adapt the formula for pairs that should trade near parity, such as two stablecoins, or let providers concentrate capital in a chosen price band. Whatever the design, a trade that is large relative to the pool always fills worse than the headline rate.
Watch out for
- · Orders large relative to the pool execute at materially worse prices
- · Providing liquidity can leave you worse off than simply holding — impermanent loss