What is an Automated Market Maker?
In this video, we explain how constant product automated market makers (AMMs) work by using a very simple and easy-to-follow story, so you can fully grasp how the algorithm behind a liquidity pool functions. Don’t worry if those sound like big or complex words — we’ve broken everything down into clear, relatable examples to make sure the concepts make sense, even if you’re brand new to decentralized finance (DeFi).
A constant product AMM is the backbone of many decentralized exchanges like Uniswap, where instead of matching buyers with sellers directly, trades are executed against a pool of assets that automatically adjusts prices based on supply and demand. The algorithm keeps the product of the quantities of the two assets constant, following the formula x * y = k, ensuring the pool always has liquidity for swaps.
Here on Whiteboard Crypto, our goal is to make difficult and technical blockchain concepts accessible and understandable for everyone. By the end of this video, you’ll have a clear understanding of how liquidity pools, automated market makers, and their pricing algorithms work — all explained in a fun, simple, and visual way. Stick around and let us help demystify one of DeFi’s most important innovations!
Description:
An AMM (Automated Market Maker) is a type of decentralized exchange (DEX) protocol that allows users to trade cryptocurrencies directly, without the need for an order book or matching buyers and sellers. Instead, AMMs use smart contracts and liquidity pools to automatically facilitate trades and set prices through algorithms.
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💡 Key Points
• Examples: Uniswap (Ethereum), PancakeSwap (BNB Chain), Curve Finance, Balancer
• No order book — eliminates the need for counterparties to match orders
• Traders swap tokens directly against a liquidity pool, which holds reserves of both tokens in a trading pair
• Prices are determined algorithmically, often using formulas like the constant product formula (x * y = k, popularized by Uniswap)
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🔑 How it works:
Liquidity providers (LPs) deposit equal values of two tokens (e.g., ETH and USDC) into a pool. In return, they earn a share of trading fees every time someone swaps between those tokens. Traders interact with these pools to exchange assets — the smart contract automatically calculates how much of each token to give or take based on pool balances.
The constant product formula ensures that as one token is bought and its supply decreases, its price rises (and vice versa). This creates a self-balancing market without manual intervention.
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🛠️ Advantages
• 24/7 liquidity — no need to wait for a buyer/seller
• Permissionless — anyone can trade or provide liquidity
• Simple user experience — instant token swaps via wallet apps
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⚠️ Risks
• Impermanent loss for liquidity providers
• Slippage during large trades or low liquidity