How Does an Automated Market Maker (AMM) Function on a DEX?
An AMM replaces the traditional order book with liquidity pools and an algorithmic pricing formula. Users deposit a pair of assets into a pool, becoming 'liquidity providers' (LPs).
The formula, often x y = k, determines the price ratio between the two assets. When a trade occurs, the ratio of assets in the pool shifts, causing the price to adjust automatically according to the algorithm.
Glossar
Liquidity Providers
Capital ⎊ These entities supply the necessary assets to decentralized exchanges or automated market makers to facilitate continuous trading in crypto derivatives and options.
Automated Market Maker
Architecture ⎊ Automated Market Makers (AMMs) represent a paradigm shift in decentralized exchange (DEX) design, moving away from traditional order book models to a constant function market mechanism.