Automated Market Maker (AMM) systems function as decentralized trading platforms that enable users to trade cryptocurrencies without needing traditional order books for their transactions.
The system functions through smart contracts together with liquidity pools which enable automatic price determination and trade execution without requiring direct buyer-seller matching. Traditional exchanges enable traders to conduct trades through price agreements that exist between buyers and sellers. AMM systems provide users with a trading platform which requires them to use a token pool that other users fund through their role as liquidity providers. Liquidity providers create asset pairings which they deliver to a smart contract that contains assets such as ETH and USDC.
The pool generates trading fees which serve as their source of income. AMMs use mathematical equations to determine their pricing. The most common model applies a constant product formula, which uses token pool ratios to determine price changes. The pool price increases when someone purchases a token because the total supply in the pool decreases. The price decreases because the supply increases when someone sells.
The system enables decentralized exchanges to operate without requiring intermediary parties for their operational needs. Uniswap and other DeFi protocols operate their platforms through AMM models, which enable them to perform on-chain trading activities. The system provides users with wallet-based trading capabilities through its automated functions and clear system design.
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AMMs create multiple dangers which their users must face. The liquidity providers face impermanent loss when token values experience major price swings. Slippage problems emerge when big trades take place in small liquidity pools. AMMs serve as essential components of decentralized finance because they allow users to trade digital assets in digital asset markets.