An Automated Market Maker (AMM) is a smart contract-based trading system. It works without traditional buyers or sellers. AMMs use liquidity pools and math formulas. They allow crypto trading 24/7 on decentralized exchanges (DEXs).
Users trade against token pools, not people. These pools are funded by liquidity providers (LPs). LPs earn fees from each trade. The most common formula is x * y = k. Here, x and y are token amounts. The product (k) stays constant.
AMMs offer fast, permissionless trading. They support many crypto pairs. There’s no need for a central order book. Risks include impermanent loss and scam tokens. Despite this, AMMs are vital to the DeFi ecosystem.
How Do Automated Market Makers Work?
Automated Market Makers (AMMs) work through smart contracts called liquidity pools, not traditional buyers and sellers. Users deposit cryptocurrencies into these pools. The AMM then uses a mathematical formula to set token prices. The most common is the constant product formula x * y = k. It adjusts prices based on the ratio of tokens in the pool.
If a user swaps tokens, they trade against the pool, not another person. This removes the need for centralized order books. The algorithm changes the pool’s balance automatically. Liquidity providers (LPs) earn fees from trades as rewards for supplying tokens. The system allows permissionless trading and keeps DeFi markets open 24/7.
According to Gemini’s Cryptopedia, AMMs help keep decentralized finance liquid and accessible. They automate pricing and enable continuous trading without relying on traditional market structures.
Automated Market Makers (AMMs) – How Do They Compare With Legacy Systems?
AMMs operate on decentralized blockchain protocols, using smart contracts and liquidity pools to enable peer-to-peer trading without intermediaries. In contrast, legacy systems depend on centralized exchanges, institutional market makers, and traditional order books to match buyers and sellers.
Legacy systems are controlled by central authorities, require significant infrastructure, and limit access to regulated entities. AMMs, on the other hand, offer open participation, transparency, and lower barriers to entry. Anyone with a crypto wallet can trade or provide liquidity.
Traditional systems rely on bid-ask spreads for profits and run during fixed hours. AMMs function 24/7 and adjust prices automatically based on asset ratios in pools. Though AMMs face issues like impermanent loss and slippage. They continue evolving with innovations like dynamic fees and multi-asset pools. AMMs represent a shift towards democratized finance—challenging traditional gatekeepers and enabling a more inclusive trading environment.
pm-AMM—A Uniform AMM For Prediction Markets
The pm-AMM (prediction market automated market maker) is a specialized AMM built to address the unique needs of prediction markets—platforms where tokens pay $1 if an event occurs and $0 if it doesn’t. These tokens, known as outcome tokens, behave very differently from traditional assets.
In fact, their volatility depends not only on how likely an event is but also on how close the market is to expiration. This makes it hard for standard AMMs like Uniswap’s constant product model (CPMM) or the logarithmic market scoring rule (LMSR) to manage risk and liquidity efficiently. Consequently, these AMMs often lead to inconsistent liquidity and higher losses for liquidity providers (LPs) near expiry.
If you want to solve this, the pm-AMM introduces a model based on Gaussian score dynamics, which mirrors how probabilities change over time in real-world prediction events—like elections, sports games, or asset prices crossing a threshold. Moreover, pm-AMM is designed to minimize the volatility of liquidity losses by using a metric called loss-vs-rebalancing (LVR). This metric measures how much LPs lose to arbitrage when AMM prices lag behind real probabilities.
Now, there are two versions of pm-AMM:
- The Static pm-AMM keeps LVR uniform across all prices but lets it increase as the market nears expiration.
- The Dynamic pm-AMM adjusts liquidity over time, ensuring the LVR remains consistent as the event approaches.
Ultimately, pm-AMM represents a major improvement for prediction markets. It not only ensures more efficient pricing and liquidity but also sets a foundation for designing custom AMMs for other assets—like bonds, options, or stablecoins—that don’t follow traditional price behavior.
Types of AMM Algorithms
Automated Market Maker (AMM) algorithms define how decentralized exchanges price assets and manage liquidity. In general, there are four core types of AMM algorithms, each designed for specific asset behaviors and use cases:
1. Constant Product Market Maker (CPMM)
Popularized by—Uniswap V1/V2
Formula: x × y = k
In fact, this is the most common AMM model. It ensures that the product of the two token reserves remains constant. However, it suffers from impermanent loss during high volatility and provides limited price stability.
2. Constant Sum Market Maker (CSMM)
Formula: x + y = k
This model offers zero slippage but fails under high demand. Consequently, it’s unsuitable for trading since it can drain one side of the pool completely. It’s rarely used in production environments.
3. Hybrid Constant Function Market Maker (CFMM)
Popularized by—Curve Finance
Formula: A combination of CPMM and CSMM
Moreover, this hybrid model is ideal for stablecoins or correlated assets. It offers low slippage and efficient liquidity within a narrow price range. The algorithm adapts between CPMM and CSMM depending on volatility.
4. Constant Mean Market Maker (CMMM)
Popularized by—Balancer
Formula: (x¹ × x² × … × xn)^(1/n) = k
Unlike CPMM, this allows multiple tokens and custom weightings in a pool (e.g., 80/20 instead of 50/50). As a result, it supports more flexible portfolio management and diversified exposure with reduced impermanent loss.
5. Virtual AMM (vAMM)
Popularized by—Perpetual Protocol
Use case—Derivatives and perpetual contracts
Instead of real asset swaps, vAMMs use virtual balances to simulate trading and set prices. Consequently, they separate pricing from collateral, reducing the need for traditional liquidity providers.
Benefits of Using AMMs
AMM stands for Automated Market Maker — a type of decentralized exchange (like Uniswap, Curve, Balancer) where smart contracts automatically set prices and execute trades without traditional order books or middlemen.
The bullet list explains why AMMs are beneficial, using clear structure and transition words like in fact, moreover, consequently. Each point explains a key advantage of using AMMs in crypto or decentralized finance (DeFi):
- Open to anyone – No permission or approval needed.
- Always available – Works 24/7 with no downtime.
- Transparent – Uses visible code and formulas to set prices.
- Easy earnings – Anyone can provide tokens and earn fees.
- Fast launch for tokens – New tokens can trade right away.
The Ins and Outs of Decentralized Exchanges (DEXs)
The Ins and Outs of Decentralized Exchanges (DEXs) refers to how DEXs allow users to trade cryptocurrencies directly through smart contracts, without any centralized intermediary. These platforms are non-custodial, meaning users keep control of their private keys and funds at all times. DEXs operate using one of three models—automated market makers (AMMs), order book systems, or DEX aggregators. AMMs rely on liquidity pools to price assets, order book DEXs match buyers and sellers directly, and aggregators source the best rates from multiple DEXs.
Compared to centralized exchanges, DEXs offer more privacy, enhanced user control, and resistance to censorship. However, they also come with higher responsibility—users must manage wallets, understand blockchain compatibility, and avoid common pitfalls like slippage errors or sending funds across incompatible chains.
Overall, DEXs support decentralized finance (DeFi) by promoting peer-to-peer trading. It offers a wide range of tokens, and enables liquidity rewards—all while minimizing reliance on centralized authorities.
What Makes AMMs So Popular in DeFi?
Automated Market Makers (AMMs) are popular in DeFi because they remove the need for central intermediaries or traditional order books. In fact, they let users trade directly from their wallets using smart contracts. Anyone can become a liquidity provider without needing approval. Moreover, AMMs rely on mathematical algorithms to automate trades. It keeps markets active even during high volatility. This structure supports global access, simplifies trading, and maintains transparency through blockchain security.
Now, another reason AMMs thrive is their reward system for liquidity providers. Participants earn a share of trading fees, making it profitable to contribute tokens. Consequently, more users join and sustain liquidity across platforms. All activity remains publicly verifiable, reinforcing user trust.
What’s the Difference Between Uniswap, Curve, Balancer, and dYdX?
Uniswap, Curve, Balancer, and dYdX are all prominent players in the AMM space, but each serves different functions within the DeFi ecosystem. Uniswap operates on the constant product formula (x * y = k) and supports a wide range of ERC-20 token swaps through simple, permissionless pools. Curve specializes in low-slippage trades between stablecoins and similar assets. It makes it ideal for stablecoin liquidity and yield farming. Balancer allows users to create custom liquidity pools with multiple tokens and variable weights, offering more flexibility than the standard 50/50 token pairs.
dYdX, on the other hand, takes a different approach by combining decentralized trading with order book functionality and derivatives like perpetual contracts. It’s designed for advanced traders looking for margin and leverage options, unlike the more pool-centric models of Uniswap and Curve.
Each of these platforms addresses specific trading needs. This makes them collectively vital to the DeFi infrastructure. For a full breakdown and deeper explanation, you can explore the original guide from OSL Academy.
What Is The Future of AMMs in Decentralized Finance?
In fact, the future of AMMs is shifting toward greater capital efficiency and interoperability. Innovations like Uniswap V3’s concentrated liquidity and virtual reserves allow deeper markets with less capital. Moreover, cross-chain AMMs such as LiFi and Rubic are reducing fragmentation across networks, enabling smoother token swaps and unified liquidity pools.
Now, AMMs are also powering the tokenization of real-world assets, opening access to markets like real estate and art. Consequently, this boosts fractional ownership and 24/7 trading. With Layer 2 solutions like Arbitrum and zkSync, AMMs can offer faster, cheaper, and more scalable trading. According to Nicolas Gallet’s research, AMMs are set to become the core infrastructure of decentralized finance (source).
Final Thoughts—Are AMMs Right For You?
Now, if AMMs are right for you depends on your goals in the DeFi space. If you seek decentralized trading with full custody over your assets, AMMs offer unmatched autonomy. In fact, you don’t need a broker or exchange—just your wallet and a supported dApp. Moreover, if you’re interested in earning passive income, becoming a liquidity provider can be rewarding. But keep in mind risks like impermanent loss and MEV. Consequently, AMMs work best for users who understand these trade-offs and want direct access to open financial markets.
So, ultimately, AMMs are ideal for those who value transparency, decentralization, and financial experimentation. If that’s you, the DeFi frontier might just be your next step.
