Automated Market Makers

Automated Market Makers (AMMs) are a type of Decentralized Exchange (DEX) that use algorithms, typically the Constant Product Market Making (CPMM) formula, to determine the prices of assets being traded on the platform. These algorithms take into account the supply and demand of the assets being traded, as well as other factors, to set prices and facilitate orders. One of the key features of AMMs is their use of liquidity pools. A liquidity pool is a pool of funds provided by users of the DEX that is used to facilitate trading. When a user wants to trade a particular asset, they can do so by providing some of their own assets to the liquidity pool. This helps to ensure that there is always sufficient liquidity on the DEX to match buy and sell orders.

Liquidity pools are a key part of AMMs because they allow the DEX to operate without the need for a central authority or traditional order book. This makes AMMs highly decentralized, which is one of the main advantages of DEXs over centralized exchanges.

In addition to providing liquidity, users who contribute assets to a liquidity pool may also earn fees for their participation. This is because the algorithms used by AMMs to set prices and match orders often take a small fee from each trade, which is then distributed to the users who have provided liquidity to the pool.

AMMs and DEXs are an important part of the broader ecosystem of Decentralized Finance (DeFi), and their use of liquidity pools plays a crucial role in enabling trustless and efficient trading on these platforms.