How Do Automated Market Makers (AMMs) Actually Work?

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The Problem AMMs Solve

Automated Market Makers revolutionized crypto trading by eliminating the need for traditional order books. Instead of matching buyers with sellers, AMMs use mathematical formulas and liquidity pools to enable instant trades.

How Automated Market Makers Work The Constant Product Formula x * y = k x = Token A reserve amount y = Token B reserve amount k = Constant (must stay same after trades) Price is determined by the ratio: Price = y / x AMM Types Uniswap v2 (x*y=k) Simple, works for all pairs Curve (StableSwap) Optimized for stablecoins Uniswap v3 (Concentrated) LPs choose price ranges
The constant product formula and AMM types

Key Takeaways

  • AMMs use mathematical formulas (x*y=k) instead of order books
  • Price is determined by the ratio of tokens in the pool
  • Trades change the ratio, which changes the price
  • Liquidity providers earn fees but face impermanent loss
  • Different AMM types optimize for different use cases
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