Lesson · [ 25 ]

AMMS & LIQUIDITY POOLS

Intermediate7 min

Plain English

Automated Market Makers (AMMs) like Uniswap replace order books with shared pools of two tokens. Anyone can deposit equal value of both to become a liquidity provider, earning a slice of every trade fee.

Going deeper

Uniswap v2 uses the constant product formula x*y=k: as one token is bought from the pool, its price rises automatically. LPs earn 0.3% on every trade, distributed proportionally to pool share. The catch is impermanent loss: if token prices diverge after deposit, LPs end up with more of the falling token and less of the rising one — under-performing simply holding the original mix. Uniswap v3 added concentrated liquidity, allowing LPs to specify a price range for higher fee capture but more active management. AMMs work well for stable-stable and high-volume pairs; volatile pairs often produce IL exceeding fees earned.

Examples

Impermanent loss math

You deposit $1k ETH and $1k USDC at $2k/ETH. ETH rises to $4k. The pool's auto-rebalance leaves you with less ETH and more USDC, totaling about $2,828 — but holding 0.5 ETH + $1k USDC would be $3,000. The gap is impermanent loss.

Stable pair LP

USDC/USDT pools rarely diverge from $1/$1, so impermanent loss is near zero. With $1B+ in volume daily, even 0.04% fees compound to 4-8% APR for passive LPs.