An Automated Market Maker (AMM) is a type of decentralized exchange (DEX) protocol that replaces traditional market makers with smart contracts and algorithms. Instead of using an order book with buyers and sellers setting prices, AMMs rely on liquidity pools, where users deposit pairs of assets (for example, ETH and DAI). The protocol then uses a pricing formula to automatically determine the exchange rate based on the ratio of assets in the pool.

This system enables peer-to-peer trading without intermediaries or custodians, making the process more transparent, efficient, and trustless. AMMs often integrate price oracles to track real-time market prices. When discrepancies occur between the pool price and external market prices, arbitrage traders step in, helping to realign values.

Compared to traditional order book models, AMMs provide continuous liquidity regardless of market activity. Their popularity stems from simplicity, low fees, and accessibility. However, they also introduce unique risks such as impermanent loss for liquidity providers.