amm

What Is an Automated Market Maker (AMM)?

An Automated Market Maker (AMM) is an on-chain trading mechanism that determines token prices and facilitates swaps according to fixed rules. In this context, a “market maker” refers to the entity providing liquidity and price quotes for trading pairs. All rules are enforced by smart contracts.

Unlike traditional order book systems, AMMs rely on liquidity pools. A liquidity pool is a shared pool of funds where multiple users deposit tokens. Anyone can swap tokens directly with the pool, without needing a counterparty.

Why Are Automated Market Makers (AMMs) Important?

AMMs make it easier to trade small-cap and long-tail assets by removing the need to wait for order matching. With liquidity pooled together, counterparties are always available, significantly lowering the barrier to entry for trading.

As of 2025, AMMs remain one of the dominant models for on-chain swaps, especially for stablecoin exchanges, long-tail asset trading, and cross-chain ecosystems. They reduce reliance on professional market making teams, lower operational costs, and promote open access.

How Do Automated Market Makers (AMMs) Work?

AMMs use mathematical formulas to control pricing and inventory. The most common formula is the “constant product” rule, where the product of two token reserves in a pool remains unchanged. When a user swaps one token for another, the reserve ratio shifts, and the price automatically updates.

For example, imagine a pool with 100 units each of Token A and Token B. If someone swaps A for B, the pool’s A reserve increases and B reserve decreases. To maintain the constant product formula, the system raises the relative price of B, so each subsequent trade yields less B. This is how automated pricing is achieved.

Arbitrage traders help keep AMM prices in line with external markets by exploiting price differences between pools and broader markets. Their activity gradually narrows these gaps, ensuring AMM prices remain competitive.

How Do AMMs Determine Prices and Handle Slippage?

Prices on AMMs are determined by changes in the ratio of assets within the pool. Larger trades have a greater impact on this ratio, causing the execution price to deviate more from the expected quote.

“Slippage” refers to the difference between the expected price at order placement and the actual executed price. Slippage increases when liquidity is low or when transaction sizes are large. Stablecoin-focused AMMs often use smoother pricing curves to minimize slippage, making them ideal for assets with similar valuations.

Common strategies to reduce slippage include: choosing pools with deeper liquidity, splitting large orders into smaller ones, or utilizing “concentrated liquidity” AMMs (which allocate capital within specific price ranges to increase trade efficiency).

How Do AMMs Generate Earnings for Liquidity Providers?

AMMs charge trading fees to users and distribute these fees proportionally to liquidity providers (LPs)—the users who deposit assets into the pools.

In addition to trading fees, some pools offer extra incentives like token rewards or “liquidity mining.” However, returns are not guaranteed; market price movements can affect final yields.

A key concept for liquidity providers is “impermanent loss.” This occurs when the relative price of two pooled assets changes—if simply holding the assets would have resulted in higher value than providing liquidity, an LP incurs a loss. If prices revert or fee earnings are high enough, losses may decrease or be offset.

What Are the Risks of Using AMMs?

The main risk is price-related: impermanent loss and high volatility can result in LPs’ assets being worth less than simply holding them. There’s also trading risk: shallow pools can lead to high slippage and significant price impact.

Technical risks exist as well—smart contracts may contain bugs or be exploited, resulting in fund losses. Operational risks include selecting the wrong pool, granting excessive permissions, or interacting with counterfeit applications.

Prioritize fund safety. Before participating in AMMs, review smart contract sources, read risk disclosures, set reasonable slippage limits, and only invest funds you can afford to lose.

How to Provide Liquidity Using AMMs on Gate

You can participate in market making on Gate by connecting through its Web3 portal or wallet to supported on-chain AMM applications.

Step 1: Prepare your wallet and funds. Set up a compatible wallet and ensure you have both network tokens for gas fees (such as mainnet tokens) and the assets you wish to provide.

Step 2: Select an AMM pool. Prioritize pools with clearly defined asset pairs, deep liquidity, and reputable contract sources. Review past trading fees and pool size.

Step 3: Add liquidity. Follow on-screen instructions to deposit two or more assets in the required proportions. Pay attention to any “concentrated liquidity” settings if choosing a specific price range.

Step 4: Monitor and claim fees. Regularly check your fee earnings and asset prices. Adjust your range or exit the pool as needed to withdraw both your fees and principal back to your wallet.

When interacting with on-chain applications via Gate, always confirm you’re using official interfaces, verify contract addresses and permissions, and implement sensible risk controls such as slippage limits and order splitting.

How Do AMMs Differ from Order Book Trading?

AMMs use liquidity pools at their core—traders swap tokens directly with the pool. Order book trading relies on order placement and matching engines to connect counterparties.

AMMs are ideal for long-tail assets and stablecoin pairs due to their low entry barrier and automatic pricing. Order book trading offers greater flexibility in price discovery and market depth management, making it better suited for large trades and sophisticated strategies. Both models often coexist, allowing users to choose based on their needs.

Key Takeaways and Learning Path for Automated Market Makers

Automated Market Makers use mathematical formulas to drive pricing, rely on liquidity pools for counterparties, distribute fees to liquidity providers, and leverage arbitrage activity to keep prices aligned with broader markets. Participants should understand slippage and impermanent loss, as well as contract and operational risks.

For learning: start by understanding the roles involved and how liquidity pools work; then study pricing mechanisms and curve variations; finally practice adding liquidity and tracking fee earnings. From there, explore advanced topics such as “concentrated liquidity” and cross-chain use cases—staying informed about on-chain trends and risk management practices as of 2025.

FAQ

I’m new to AMMs and want to start market making but don’t know where to begin. What should I do?

If you’re new, start in Gate’s liquidity mining section with lower-risk pairs like stablecoins and begin with small amounts. Learn core concepts such as slippage and impermanent loss before committing larger sums. Gate offers comprehensive tutorials and yield calculators to help you get started quickly.

Why do AMM trading prices sometimes differ significantly from other exchanges?

Such discrepancies are mainly due to slippage—the larger the trade size, the higher the slippage. Liquidity depth varies across different AMMs; deeper pools have smaller price deviations. On major platforms like Gate, popular pairs usually experience low slippage, while illiquid tokens may be more volatile.

Do I need to provide two types of tokens when supplying liquidity to an AMM?

Yes, participating in an AMM typically requires depositing both tokens in a pair in proportionate value (e.g., equal amounts of ETH and USDT for an ETH/USDT pool). Platforms like Gate offer one-click liquidity addition features that automatically allocate assets according to required ratios.

How exactly does impermanent loss occur? When is it most severe?

Impermanent loss occurs when there’s a significant price divergence between the two tokens you’ve supplied—the greater the divergence, the higher the loss. It’s most severe during large price swings; for instance, providing liquidity to an ETH/USDT pair when ETH doubles in price may leave you with less total value than simply holding ETH outright—even after fees. Choosing asset pairs with strong price correlation (such as stablecoins) can greatly reduce impermanent loss.

Is liquidity shared across different AMM platforms or are they separate?

Each platform’s AMM liquidity is generally independent—pools operate separately across different platforms. However, cross-chain bridging technology allows certain tokens to move between platforms. Large platforms like Gate typically offer deep liquidity; beginners are advised to use established venues for better trading experience and security.