AMM

An AMM, or automated market maker, is a smart contract that prices and executes token trades using a mathematical formula and a pool of deposited assets, instead of matching individual buy and sell orders. Traders swap against the pool directly, and the formula adjusts the price after every trade based on the ratio of assets remaining. The classic design, used by Uniswap, is the constant product formula x * y = k: the quantities of the two pooled tokens must always multiply to the same number, so buying one token from the pool makes it scarcer and therefore more expensive.

A concrete example: an ETH/USDC pool holds both tokens deposited by liquidity providers. When a trader swaps USDC for ETH, the contract adds their USDC to the pool, removes the corresponding ETH, and the formula shifts the price slightly upward for the next buyer. Large trades relative to pool size move the price more — this is slippage.

A common misconception is that an AMM sets prices independently; in practice, arbitrage traders keep pool prices aligned with the wider market by trading whenever the pool drifts away from prices elsewhere. AMMs made it possible for anyone to create a market for any token pair without permission, which is a foundational building block of DeFi.