💻Lumi Study Notes: What is AMM? How did I first understand how AMM quotes me?

AMM is the Automated Market Maker mechanism, one of the most fundamental and important concepts in DeFi (Decentralized Finance).

✅ One-sentence explanation of AMM

It does not require traditional "buyers versus sellers," but automatically quotes you through an algorithmic formula, allowing you to buy and sell tokens at any time.

🧩 What problem does AMM solve?

In centralized exchanges (like Binance), prices are determined by the buyers' orders + sellers' orders.

But decentralized exchanges (like Uniswap) have no order books and no market makers, so what do we do? 👉 AMM uses mathematical formulas to automatically determine prices.

🌊 What is a Liquidity Pool?

AMM does not rely on buyers and sellers to match trades but on liquidity pools (LP).

LP is like a large bucket containing two types of tokens. Others trade using the tokens in this large bucket.

Who provides liquidity? 👉 Ordinary users can deposit two tokens in proportion to become LP.

They will earn: trading fees, and sometimes platform incentive tokens.

📌 Advantages of AMM

24-hour automatic quoting, trading can happen even without orders

Convenient and simple, anyone can be an LP

Completely decentralized, no need to rely on exchanges for matching

⚠️ Risks of AMM (must-read for beginners)

⚠️1. Impermanent Loss

If the prices of the two tokens in the pool change too much, it can lead to losses for LP.

This is the most critical risk of AMM.

⚠️2. Large trades can incur slippage

Due to the algorithm of x × y = k,

the more you buy, the higher the price.

Large trades will make you pay increasingly higher prices.