An Automated Market Maker (AMM) is a type of decentralized exchange (DEX) protocol that allows users to trade cryptocurrencies directly with a liquidity pool rather than with other traders, like in traditional order books.

Here is a more detailed breakdown of how AMMs work:

1. Liquidity Pools:

Users, called liquidity providers (LPs), deposit assets (tokens) into a liquidity pool to create liquidity. They receive LP tokens in return, representing their share of the pool and entitlement to a portion of trading fees.

2. Trading:

When a trader wants to buy or sell a token, they interact directly with the liquidity pool.

3. Price Adjustment:

The AMM's algorithm uses a formula, like the constant product formula (x * y = k), to calculate the price of the tokens based on the ratio of assets in the pool. When a trade occurs, the ratios change, and the algorithm recalculates the price.

4. Fee Distribution:

A small fee is charged for each trade, and a portion of these fees is distributed to the LPs based on their share of the pool.

5. Automation:

The entire process is automated, removing the need for manual market making and matching buyers and sellers.

In essence, AMMs provide a decentralized and automated way to trade digital assets on blockchains, relying on liquidity pools and mathematical formulas instead of traditional order books.

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