How Automated Market Makers Work in DeFi

Introduction to AMMs Automated Market Makers (AMMs) revolutionized decentralized trading by replacing traditional order books with mathematical formulas. This guide explores how they work under the hood. The Constant Product Formula Uniswap popularized the constant product formula: x times y equals k. Where x is the reserve of token A, y is the reserve of token B, and k is a constant. When you buy token B with token A, you add to the A reserve and remove from the B reserve, maintaining k. Price Impact and Slippage Larger trades relative to pool size cause more slippage. This is why deep liquidity matters for efficient trading. Impermanent Loss Explained Liquidity providers face impermanent loss when token prices change. If one token doubles in price, LPs face approximately 5.72 percent loss compared to simply holding. Advanced AMM Designs Curve Finance : Uses a modified formula optimized for assets with similar values like stablecoins Balancer : Supports pools with multiple tokens and