An AMM replaces the order book with arithmetic. The best-known version keeps the product of the two reserves constant, so removing one asset from the pool raises its price along a curve. No quotes, no counterparty and no matching engine are needed — the contract will always trade, at whatever price the formula returns.
The design's strength is that it works unattended and lists anything. Its weakness is that the pool does not know the outside price: it only updates when someone trades against it, so arbitrageurs are the mechanism that keeps a pool aligned with the wider market, and the profit they take is borne by the liquidity providers.
How does an AMM know what price to quote?
It does not look anything up. The price falls out of the ratio of the assets in the pool, and arbitrage traders correct it toward the wider market by trading against any gap.
Last updated October 17, 2026