An automated market maker, or AMM, uses programmed rules to facilitate trading. In DeFi, it commonly lets traders exchange assets against liquidity supplied to a smart contract. The counterparty is the pool’s inventory rather than a separately matched limit order, although broader trading systems can combine different mechanisms.
Prices respond to the trade
A constant-product AMM relates two reserves through a rule commonly written as x × y = k before accounting for fees. Buying one asset removes it from the pool while adding the other, changing the reserve ratio and the price available for subsequent trades. Larger trades relative to available liquidity generally produce greater price impact.
Other AMMs use different curves, weights, or concentrated liquidity ranges. Arbitrage trades can bring pool prices closer to external markets, but alignment is neither immediate nor guaranteed.
The liquidity provider’s side
Liquidity providers may receive a share of trading fees while their asset mix changes with swaps. Their position can underperform simply holding the original assets, and fee income may not offset that difference. Concentrated positions can stop earning trading fees outside their active range. Contract flaws, token behavior, and pool-specific controls add further risks.