What is an AMM (Automated Market Maker)?

An Automated Market Maker (AMM) is a decentralized protocol used by exchanges to automatically set prices for trading pairs based on the amount of assets available in a liquidity pool. Unlike traditional order books, where buyers and sellers directly place orders, AMMs use algorithms (such as the constant product formula) to adjust prices in real-time. Users supply liquidity to these pools and earn a portion of the transaction fees in exchange. AMMs are essential for decentralized exchanges (DEXs) as they enable peer-to-peer trading without a centralized authority, and they provide the liquidity necessary to facilitate market activity.