An Automated Market maker (AMM) is a protocol that runs on decentralized exchanges (DEX), that takes away the order book that exists on traditional exchanges, where liquidity is provided by buyer and seller orders, and replaces it with liquidity pools, a shared pot of tokens.
Users of the AMM supply the pool with tokens after which price of an asset is calculated by a mathematical formula.
AMMs help new DEXs who would be faced with a small number of buyers and sellers trading on a regular basis – or low liquidity – early on in their existence.
As assets provided by liquidity providers (buyers and sellers) grow in the pool, so does DEX’s liquidity.
Liquidity providers are incentivized by earning a fee for their share of the pool tokens provided, and the DEX is rewarded with increased liquidity, making trading on the DEX far easier.
There are different approaches to how AMMs configure their mathematical formula for pricing and liquidity, and it’s that distinction that makes one AMM model different than the next.
Four popular AMMs in DeFi that have grown immensely in popularity are Uniswap, Pancakeswap, Curve, and Balancer.