Automated Market Maker

An Automated Market Maker (AMM) is a smart contract that enables trading by maintaining liquidity pools and using mathematical formulas to determine asset prices automatically. Instead of traditional order books where buyers and sellers directly match, AMMs allow anyone to trade against a pool of assets, with prices determined algorithmically based on the ratio of assets in the pool.

Uniswap popularized AMMs in 2018, launching with the constant-product formula (x × y = k). This simple innovation enabled decentralized trading without order books, market makers, or centralized intermediaries. As of 2026, AMMs process hundreds of billions in annual trading volume and represent the dominant trading mechanism in DeFi.

AMMs are elegant, efficient, and accessible to anyone—but they also introduce unique challenges (impermanent loss, slippage) that traditional order book exchanges don't have. Understanding how AMMs work is fundamental to DeFi.

How AMMs Work

The Constant Product Formula

The most common AMM formula is x × y = k:

Definition:

• x = amount of token A in pool
• y = amount of token B in pool
• k = constant (product of x and y at any time)

Example:

• Uniswap ETH/USDC pool with 1000 ETH and 2,000,000 USDC
• k = 1000 × 2,000,000 = 2,000,000,000

Trading

When someone swaps tokens, they:

1. Send tokens to the pool (input)
2. Receive different tokens from the pool (output)
3. The pool maintains x × y = k

Example: Swapping 100 USDC for ETH

Starting state: 1000 ETH, 2,000,000 USDC

1. User sends 100 USDC to pool
2. New USDC: 2,000,100 USDC
3. Calculate new ETH using k: 1000 × 2,000,000 = x × 2,000,100
4. x = 2,000,000,000 ÷ 2,000,100 = 999.95 ETH
5. User receives: 1000 - 999.95 = 0.05 ETH
6. Price: 100 USDC ÷ 0.05 ETH = 2000 USDC/ETH (market price)

Key Insight: As the pool becomes less balanced, prices become worse for traders (increasing slippage).

Liquidity Providers

Role: Liquidity Providers (LPs) deposit equal values of both assets to the pool.

Process:

1. LP deposits 1 ETH + 2000 USDC to the pool
2. LP receives pool tokens (LP shares) representing their portion
3. LP earns a percentage of all trading fees (typically 0.3%-1%)
4. LP can withdraw anytime by burning pool tokens

Risk: If prices diverge significantly, LPs suffer impermanent loss—they would have been better off just holding the assets.

Types of AMMs

Constant Product (Uniswap V2, Raydium)

Formula: x × y = k

Characteristics:

• Simple, elegant formula
• Requires large trades to move prices significantly
• Works well for all token pairs

Popularity: Most common AMM design.

Constant Sum (Curve Finance, in a simplified form)

Formula: x + y = k (for stablecoins)

Characteristics:

• Designed for stablecoin pairs (similar valued assets)
• Much lower slippage for similar-valued assets
• Can become unbalanced (price at boundary = infinity)

Usage: Curve dominates stablecoin trading ($10B+ daily volume).

Constant Mean (Balancer)

Formula: (x^w1) × (y^w2) = k (weighted product)

Characteristics:

• Allows arbitrary weights between tokens (not 50/50)
• Example: 80% USDC / 20% ETH pool
• More complex but more flexible

Usage: Balancer enables multi-token pools.

Hybrid (Curve V2, Solidly)

Formula: Combines constant-product and constant-sum properties

Characteristics:

• Low slippage for similar-valued assets
• Works well across price ranges
• More complex math, higher gas costs

Usage: Next-generation AMMs with improved capital efficiency.

AMM Design Comparison

| Design | Formula | Best For | Slippage | Complexity | |--------|---------|----------|----------|------------| | Constant Product | x×y=k | All pairs, volatile | Higher | Low | | Constant Sum | x+y=k | Stablecoins | Very low | Low | | Constant Mean | x^w1 × y^w2=k | Multi-token | Medium | Medium | | Hybrid | (x×y)^p + (x+y)^q=k | Efficient all-pairs | Low-Medium | High |

Slippage and Price Impact

Slippage = difference between expected price and actual execution price.

Cause: Large trades move the price (pool becomes less balanced).

Formula: Price Impact = (Input / (Input + Pool Balance))

Example:

• Pool: 1000 USDC, 1 ETH (price = 1000 USDC/ETH)
• Swap 100 USDC for ETH
• Price impact = 100 / (100 + 1000) = 9.1%
• You get worse than market price due to slippage

Implications:

• Large trades = higher slippage = worse execution
• Slippage increases as pools become imbalanced
• Slippage decreases as pool liquidity increases

Liquidity Provider Rewards and Risks

Rewards

LPs earn:

1. Trading Fees: Percentage of every swap (0.01%-1%)
2. Incentive Tokens: Governance/protocol tokens as incentives
3. Fee Compounding: Fees automatically reinvested, earning yields on yields

Annual Yields: 1%-100%+ depending on trading volume, volatility, and incentives.

Risks

Impermanent Loss (IL): Most significant risk for LPs.

How IL Works:

1. LP deposits 1 ETH + 2000 USDC (1:2000 ratio)
2. Price changes: 1 ETH = 4000 USDC
3. Pool rebalances: LP now has 0.707 ETH + 2828 USDC
4. Current value: 0.707 × 4000 + 2828 = 5656 USDC
5. If they held: 1 × 4000 + 2000 = 6000 USDC
6. IL = 5656 - 6000 = -344 USDC loss

Why IL Happens: AMM requires 50/50 balance. As price moves, the pool sells the appreciating asset and buys the depreciating one, causing the LP to have less of the winner.

IL is "Impermanent": If price returns to original ratio, IL disappears. Only permanent if you withdraw at higher price divergence.

IL vs Fees: Low-volatility pairs (stablecoin pairs) have low IL but lower fees. High-volatility pairs have high IL but potentially higher fees.

Concentrated Liquidity (Uniswap V3)

Innovation: Instead of providing liquidity across all price ranges, provide within a specific range.

Benefits:

• Lower impermanent loss (if price stays in range)
• Higher fee earnings (same volume, less capital)
• More capital efficient

Drawbacks:

• More complex (requires managing price ranges)
• Risk if price moves outside range (0% fees until price returns)
• Requires active management

Impact: Uniswap V3 enables 4000x+ capital efficiency for stablecoins.

Popular AMM Platforms

Uniswap

Market Share: ~25% of all DeFi trading volume

Features:

• Constant product (V2) and concentrated (V3)
• Multi-chain deployment
• Strong ecosystem

Volume: $1T+ annually

Curve Finance

Specialization: Stablecoin trading

Features:

• Constant-sum formula (optimized for stablecoins)
• Extremely low slippage
• High trading volume

Volume: $500B+ annually (mostly stablecoins)

Balancer

Specialization: Multi-token pools, index investments

Features:

• Weighted pools (not just 50/50)
• Liquidity as a Service platform
• Self-balancing portfolios

Volume: $50B+ annually

PancakeSwap (BSC), Raydium (Solana)

Specialization: L2/alternative chain AMMs

Features:

• Similar to Uniswap but on different chains
• Lower fees, lower security (higher risk)

Astroport (Terra), Thruster (Blast)

Specialization: Newer chain AMMs

Features:

• Latest AMM innovations
• Lower liquidity, higher risk

Career Opportunities in AMMs

The AMM ecosystem offers diverse roles:

AMM Protocol Developer ($150,000 - $380,000+): Design and implement AMM smart contracts, optimize formulas.

Liquidity Strategy Manager ($120,000 - $350,000+): Develop strategies for LP capital allocation across pools.

AMM Arbitrage Developer ($130,000 - $340,000+): Build bots detecting and executing AMM arbitrage.

Market Maker ($100,000 - $500,000+ depending on profitability): Provide liquidity and manage LP positions for profit.

Research Economists ($140,000 - $320,000+): Study AMM design tradeoffs and optimal formula development.

Top LPs managing $10M+ in liquidity can earn $500k-$2M+ annually.

The Future of AMMs

AMMs continue to evolve:

Hybrid Designs: Combining multiple formulas for different asset types in single pools.

Intent-Based: Users specify trading intent, solvers find optimal routing across multiple AMMs.

Privacy: Private AMMs hiding trading information from other participants.

Limit Orders: AMMs supporting limit orders like traditional exchanges.

Better Capital Efficiency: New designs enabling more capital efficiency with less impermanent loss.

Cross-Chain AMMs: AMMs operating across multiple blockchains simultaneously.

AMMs have completely transformed trading, enabling billions in daily volume without centralized intermediaries. As they evolve, AMMs will likely become even more efficient, capital-friendly, and user-accessible.

Providing liquidity to AMMs? Understand impermanent loss, start with stablecoin pools if risk-averse, or volatile pairs if seeking high yields. Active management or delegating to professional LPs will likely generate better returns than passive LP positions.