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Automated Market Makers
DeFi Strategies • Yield Models • Token Income
algorithmic protocols replacing traditional order books
Automated Market Makers (AMMs) are decentralized trading protocols that use smart contracts and mathematical formulas to facilitate token swaps without order books. Prices are determined algorithmically based on the ratio of tokens in a liquidity pool, making peer-to-contract trading possible at any time without requiring a centralized intermediary.
Use Case: A trader swaps $USDC for $AVAX on Pangolin, an AMM on the Avalanche network. The AMM recalculates the price based on the current pool balance, executes the trade instantly, and updates the pool ratio—all without an order book or human counterpart.
Key Concepts:
- Liquidity Pool — Token reserves used to execute trades programmatically
- Constant Product Formula — The core pricing logic: x * y = k
- Permissionless — Anyone can trade or become an LP without approval
- Slippage Risk — Price change caused by trade size relative to pool depth
- AMM — Shorthand reference for automated market maker systems
- Swap Fee — Transaction fees distributed to liquidity providers
- LP Tokens — Receipt tokens representing pool share
- Impermanent Loss — Risk from price divergence in LP positions
- Decentralized Exchange — Trading platforms built on AMM infrastructure
- Yield Farming — Strategy leveraging AMM liquidity provision
- Smart Contracts — Self-executing code powering AMM mechanics
- DeFi Yield Models — Income structures including AMM fee revenue
- Trustless — No counterparty reliance in AMM trading
- Web3 — Decentralized internet enabling permissionless AMMs
Summary: AMMs are foundational to decentralized finance, allowing 24/7 global trading without custodians. By removing order books and automating price discovery, they empower users to access liquidity and earn yields in open, programmable ways.
The AMM Revolution
why automated market makers changed DeFi
Before AMMs (Traditional)
• Order books required liquidity
• Market makers were institutions
• Retail couldn’t provide liquidity
• KYC/identity gatekeeping
• Trading hours limited
• Geographic restrictions
• Order books required liquidity
• Market makers were institutions
• Retail couldn’t provide liquidity
• KYC/identity gatekeeping
• Trading hours limited
• Geographic restrictions
After AMMs (DeFi)
• Anyone can provide liquidity
• Earn fees by contributing capital
• 24/7 global access
• No KYC required
• Permissionless participation
• Algorithmic price discovery
• Anyone can provide liquidity
• Earn fees by contributing capital
• 24/7 global access
• No KYC required
• Permissionless participation
• Algorithmic price discovery
Key Innovation
• Replace order books with pools
• Mathematical price formula
• Smart contract execution
• Instant settlement
• Composable DeFi legos
• Replace order books with pools
• Mathematical price formula
• Smart contract execution
• Instant settlement
• Composable DeFi legos
First Movers
• Bancor (2017)
• Uniswap V1 (2018)
• Uniswap V2 (2020)
• Curve Finance (2020)
• Uniswap V3 (2021)
• Bancor (2017)
• Uniswap V1 (2018)
• Uniswap V2 (2020)
• Curve Finance (2020)
• Uniswap V3 (2021)
Impact
• $100B+ TVL at peak
• Billions in daily volume
• Foundation of DeFi
• Enabled yield farming
• Democratized trading
• $100B+ TVL at peak
• Billions in daily volume
• Foundation of DeFi
• Enabled yield farming
• Democratized trading
The Breakthrough: AMMs solved the liquidity bootstrapping problem—you don’t need professional market makers or deep order books. Anyone with two tokens can create a market. This single innovation enabled the entire DeFi ecosystem to flourish.
AMM Architecture
how automated market makers are built
Liquidity Pools
• Token pair reserves
• Example: ETH + USDC
• Users deposit both tokens
• Pool tracks total reserves
• Shares tracked via LP tokens
• Foundation of AMM trading
• Token pair reserves
• Example: ETH + USDC
• Users deposit both tokens
• Pool tracks total reserves
• Shares tracked via LP tokens
• Foundation of AMM trading
Pricing Formula
• Constant product: x × y = k
• k stays constant during swaps
• Price = y/x (or x/y)
• Larger trades = more slippage
• Arbitrageurs keep prices accurate
• Self-balancing mechanism
• Constant product: x × y = k
• k stays constant during swaps
• Price = y/x (or x/y)
• Larger trades = more slippage
• Arbitrageurs keep prices accurate
• Self-balancing mechanism
Fee Mechanism
• % of each swap (e.g., 0.3%)
• Added to pool reserves
• Distributed to LP holders
• Incentivizes liquidity
• Sustainable revenue model
• Compounds automatically
• % of each swap (e.g., 0.3%)
• Added to pool reserves
• Distributed to LP holders
• Incentivizes liquidity
• Sustainable revenue model
• Compounds automatically
LP Token System
• Receipt for liquidity provided
• Represents % of pool
• Entitles holder to fees
• Redeemable for underlying
• Can be staked for extra yield
• Composable in DeFi
• Receipt for liquidity provided
• Represents % of pool
• Entitles holder to fees
• Redeemable for underlying
• Can be staked for extra yield
• Composable in DeFi
Smart Contract Layer
• Immutable trading logic
• Trustless execution
• No admin key risk (ideally)
• Audited and battle-tested
• Open source code
• Anyone can verify
• Immutable trading logic
• Trustless execution
• No admin key risk (ideally)
• Audited and battle-tested
• Open source code
• Anyone can verify
Elegance: AMM architecture is remarkably simple—two token reserves, one formula, automatic pricing. Yet from this simplicity emerged a multi-billion dollar ecosystem. The constant product formula (x × y = k) is perhaps the most impactful equation in crypto.
AMM Generations
evolution of automated market maker design
Evolution Pattern: Each generation addresses limitations of the previous. Gen 1 established the model. Gen 2 optimized for specific use cases. Gen 3 improved capital efficiency. Gen 4 added external intelligence. Protocol-level AMMs eliminate smart contract risk entirely.
Major AMM Protocols
leading platforms across ecosystems
Uniswap
• Largest by volume
• Ethereum + L2s
• V2: Simple, reliable
• V3: Concentrated liquidity
• Industry standard
• $5B+ TVL
• Largest by volume
• Ethereum + L2s
• V2: Simple, reliable
• V3: Concentrated liquidity
• Industry standard
• $5B+ TVL
Curve Finance
• Stablecoin specialist
• Ultra-low slippage
• veTokenomics pioneer
• Multi-chain deployment
• Deep liquidity
• DeFi backbone
• Stablecoin specialist
• Ultra-low slippage
• veTokenomics pioneer
• Multi-chain deployment
• Deep liquidity
• DeFi backbone
Pangolin
• Avalanche native
• Community-driven
• Multi-chain expansion
• Fair launch token
• Ecosystem integrations
• AVAX trading hub
• Avalanche native
• Community-driven
• Multi-chain expansion
• Fair launch token
• Ecosystem integrations
• AVAX trading hub
SparkDEX
• Flare ecosystem
• FLR/SPARK trading
• Growing liquidity
• Community AMM
• Yield opportunities
• Track via FLR Metrics
• Flare ecosystem
• FLR/SPARK trading
• Growing liquidity
• Community AMM
• Yield opportunities
• Track via FLR Metrics
XRPL AMM
• Protocol-level native
• No smart contract risk
• Integrated with DEX
• Auction slot mechanism
• LP-set fee tiers
• XRP Ledger innovation
• Protocol-level native
• No smart contract risk
• Integrated with DEX
• Auction slot mechanism
• LP-set fee tiers
• XRP Ledger innovation
Trader Joe
• Avalanche leader
• Liquidity Book (V2)
• Bin-based liquidity
• Zero-slippage zones
• JOE token rewards
• Innovation focused
• Avalanche leader
• Liquidity Book (V2)
• Bin-based liquidity
• Zero-slippage zones
• JOE token rewards
• Innovation focused
Ecosystem Choice: Select AMM based on your chain, trading pairs, and goals. Uniswap for Ethereum/L2s, Curve for stables, Pangolin for Avalanche, SparkDEX for Flare. XRPL’s native AMM offers unique security advantages for XRP ecosystem participants.
AMM Participation Roles
how different users interact with automated market makers
Traders (Swappers)
• Use AMMs to exchange tokens
• Pay swap fees on each trade
• Benefit from instant execution
• No counterparty needed
• 24/7 availability
• Permissionless access
• Use AMMs to exchange tokens
• Pay swap fees on each trade
• Benefit from instant execution
• No counterparty needed
• 24/7 availability
• Permissionless access
Liquidity Providers (LPs)
• Deposit tokens to pools
• Earn share of swap fees
• Bear impermanent loss risk
• Receive LP tokens
• Enable trading to happen
• Passive yield opportunity
• Deposit tokens to pools
• Earn share of swap fees
• Bear impermanent loss risk
• Receive LP tokens
• Enable trading to happen
• Passive yield opportunity
Arbitrageurs
• Profit from price differences
• Keep AMM prices accurate
• Trade against mispriced pools
• Essential for price discovery
• Competition = efficiency
• Often automated bots
• Profit from price differences
• Keep AMM prices accurate
• Trade against mispriced pools
• Essential for price discovery
• Competition = efficiency
• Often automated bots
Protocol/Governance
• Set fee parameters
• Vote on upgrades
• Manage treasury
• Direct incentives
• Govern protocol development
• Token holder rights
• Set fee parameters
• Vote on upgrades
• Manage treasury
• Direct incentives
• Govern protocol development
• Token holder rights
Ecosystem Balance: AMMs work because these roles are balanced. Traders need liquidity, LPs need volume (fees), arbitrageurs keep prices accurate, and governance ensures sustainability. Each participant contributes to and benefits from the system.
AMM Risks and Considerations
what to understand before participating
LP-Specific Risks
• Impermanent Loss — Price divergence cost
• Smart Contract Risk — Code vulnerabilities
• Rug Pulls — Malicious token projects
• Low Volume — Insufficient fee income
• Gas Costs — Entry/exit expenses
• Complexity — V3 range management
• Impermanent Loss — Price divergence cost
• Smart Contract Risk — Code vulnerabilities
• Rug Pulls — Malicious token projects
• Low Volume — Insufficient fee income
• Gas Costs — Entry/exit expenses
• Complexity — V3 range management
Trader-Specific Risks
• Slippage — Large trades move price
• Front-Running — MEV extraction
• Sandwich Attacks — Price manipulation
• Failed Transactions — Gas wasted
• Wrong Tokens — Fake/scam tokens
• Price Impact — Thin liquidity pools
• Slippage — Large trades move price
• Front-Running — MEV extraction
• Sandwich Attacks — Price manipulation
• Failed Transactions — Gas wasted
• Wrong Tokens — Fake/scam tokens
• Price Impact — Thin liquidity pools
Mitigations (LP)
• Choose stable pairs
• Use audited protocols
• Calculate IL break-even
• Monitor positions
• Diversify pools
• Choose stable pairs
• Use audited protocols
• Calculate IL break-even
• Monitor positions
• Diversify pools
Mitigations (Trader)
• Set slippage limits
• Use MEV protection
• Verify token contracts
• Check liquidity depth
• Small test trades first
• Set slippage limits
• Use MEV protection
• Verify token contracts
• Check liquidity depth
• Small test trades first
Alternative Yield
• Kinesis Holder’s Yield
• Zero IL risk
• No smart contracts
• Real-world revenue
• Truly passive
• Kinesis Holder’s Yield
• Zero IL risk
• No smart contracts
• Real-world revenue
• Truly passive
Honest Assessment: AMMs democratized trading and yield, but they’re not risk-free. Most retail LPs underperform simply holding. If you want passive yield without IL, smart contract risk, or complexity, consider Kinesis—revenue-backed yield from real economic activity.
AMM Participation Checklist
trading and providing liquidity safely
For Traders
☐ Verify token contract addresses
☐ Check pool liquidity depth
☐ Set appropriate slippage tolerance
☐ Consider MEV protection (Flashbots)
☐ Review price impact before confirming
☐ Start with small test trade
☐ Verify token contract addresses
☐ Check pool liquidity depth
☐ Set appropriate slippage tolerance
☐ Consider MEV protection (Flashbots)
☐ Review price impact before confirming
☐ Start with small test trade
For Liquidity Providers
☐ Understand impermanent loss
☐ Calculate expected fee income
☐ Verify protocol audit status
☐ Assess token pair risk
☐ Monitor position performance
☐ Know when to exit
☐ Understand impermanent loss
☐ Calculate expected fee income
☐ Verify protocol audit status
☐ Assess token pair risk
☐ Monitor position performance
☐ Know when to exit
Protocol Selection
☐ Established track record
☐ Sufficient TVL and volume
☐ Active development team
☐ Community governance
☐ Clear fee structure
☐ Network you trust
☐ Established track record
☐ Sufficient TVL and volume
☐ Active development team
☐ Community governance
☐ Clear fee structure
☐ Network you trust
The Principle: AMMs are foundational DeFi infrastructure enabling permissionless trading and yield. Participate informed—understand the mechanics, assess the risks, and secure your assets properly. For truly passive income without AMM complexity, Kinesis Holder’s Yield offers a simpler path.