In the world of decentralised finance (DeFi), one innovation stands above most as the engine of decentralised trading: the Automated Market Maker (AMM). These protocol-based markets have transformed how crypto assets are traded, replacing the slow, centralised order books of traditional finance with an elegant, automated peer-to-peer system. AMMs are the core technology behind decentralised exchanges (DEXs), allowing users to trade cryptocurrencies instantly and without intermediaries.
What Did AMMs Replace? The Traditional Order Book vs. Automated Markets
In a traditional exchange (e.g., stock markets or centralised crypto platforms), trading relies on an order book matching buyers with sellers. You submit a bid or ask, and a matching counterparty must appear for the trade to execute.
With AMMs, this matching model is replaced by a smart-contract pool: instead of waiting for a buyer to match your sell order of 1 ETH at $3,000, you trade directly against a pool of assets maintained by the protocol—so execution is immediate.
“AMMs are a component of the DeFi ecosystem, enabling permissionless and automatic trading of digital assets.”
Thus: AMMs = smart-contract + liquidity pool + pricing algorithm → trade instantly.
How AMMs Create Constant Liquidity
Liquidity Pools: The Core Mechanism
At the heart of every AMM is a liquidity pool: a smart contract holding reserves of two (or more) different tokens. These reserves are supplied by users called liquidity providers (LPs). For example, someone deposits $1,000 worth of Token A and $1,000 worth of Token B into a pool.
When a trader wants to swap Token A for Token B, they do so directly with the pool.
The Pricing Formula
The most common pricing algorithm is the constant-product formula:
x = quantity of Token A in the pool
y = quantity of Token B in the pool
k = constant (so long as no external deposit/withdraw happens)
x * y = kWhen a trade occurs (say someone sells Token A into the pool):
The pool receives more of Token A → x increases
To maintain k, y must decrease → the pool gives out Token B
The price of Token A in terms of Token B adjusts based on the new ratio
This formula ensures price adjustment based on supply/demand rather than a traditional order-book.
Benefits
Continuous liquidity: Trades can happen 24/7 without waiting for a matching counter-party.
Permissionless: Anyone can trade or provide liquidity (subject to protocol rules).
Decentralised: No intermediary is required; trades happen via smart contracts.
Risks / nuances
Price impact & slippage: If the pool is small relative to trade size, the price shifts significantly. Larger liquidity pools reduce that impact.
Impermanent loss: LPs may end up worse off than just holding tokens if price ratios move significantly.
Smart-contract risk: Bugs, hacks, or poorly designed pools can result in losses.
The Role of LPs (Liquidity Providers) & Trading Fees
So, why would anyone lock up crypto in a liquidity pool? Because of incentives.
LPs deposit token pairs into pools and, in return, receive LP tokens (representing their share of the pool) and a share of trading fees.
Every time someone swaps via the pool, the AMM charges a small trading fee (often ~0.3 %) which is added back into the pool and thus increases the pool’s total value.
Over time, LPs can withdraw their share of the pool (their original deposit + accumulated fees) by redeeming their LP tokens.
This creates a passive-income opportunity albeit one that comes with the risks noted above.
Hoopy, Hoops Finance’s mascot, checking AMM data
This guide will explore how AMMs work, their fundamental role in DeFi, how they generate constant liquidity and highlight emerging developments on Stellar using Soroban smart contracts.
AMMs on Stellar: A New Frontier with Soroban Smart Contracts
While AMMs have been long-established on chains like Ethereum (via protocols such as Uniswap) and others, the Stellar Network is emerging as a major player with its new smart-contract platform, Soroban.
What is Soroban?
Soroban is Stellar’s Rust-based smart contract environment, designed to extend Stellar’s traditional payments-first architecture into full-scale DeFi. It offers low fees, fast settlement, and compatibility with Stellar’s payment rails.
Key Protocols
Blend: A modular lending and borrowing protocol built on Soroban, allowing anyone to launch isolated lending pools with custom parameters. It focuses on capital efficiency, risk isolation, and low fees — powering DeFi credit markets on Stellar.
🔗 blend.capital • Docs
Comet → comet.hoops.finance is a lightweight frontend built by Hoops Finance to interact with Blend’s Backstop module, letting users deposit, monitor, and manage capital protection directly through an intuitive interface.
Trade today at comet.hoops.finance
Aquarius
Stellar’s original liquidity layer, now evolving into a native Soroban AMM. It rewards liquidity providers, enables token swaps, and lets AQUA holders vote on which markets receive incentives.
🔗 aqua.network • Docs
SoroSwap
A Soroban-based AMM and aggregator that finds the best swap routes across multiple liquidity sources like Aquarius and Phoenix. Users can provide liquidity or trade directly through its on-chain router.
🔗 soroswap.finance • Docs
PhoenixDEX
Part of the Phoenix DeFi Hub, PhoenixDEX offers low-fee token swaps, liquidity pools, and incentives on Stellar. It’s designed as a core building block for a full-stack DeFi ecosystem.
🔗 phoenix-hub.io • GitHub
Why AMMs Matter: The Central Engine of DeFi
They power DEXs: Most major DEXs today (Uniswap, SushiSwap, Curve, etc.) rely on AMM models, making them foundational to DeFi.
They enable financial inclusion & permissionless markets: No order book gatekeepers, no KYC (in many cases), and continuous trading.
They create yield-opportunities: LPs can earn fees; traders can swap assets easily; protocols can innovate (e.g., concentrated liquidity, dynamic fees).
They drive innovation: Research is ongoing into more capital-efficient curves (e.g., concentrated liquidity, dynamic fee structures) and optimised LP strategies.
Key Takeaways for Builders, Traders & Analysts
Understand how the pool + algorithm mechanics work (e.g., constant-product).
Recognize the trade-offs for LPs: earning fees vs. impermanent loss + smart contract risk.
For developers: Look at emerging AMM designs (e.g., on Soroban, new blockchains) and innovations (fee models, aggregated routing).
For analysts: AMM-driven data (liquidity depth, pool size, fees earned, slippage metrics) can signal health of DEX ecosystems — including platforms like those on Stellar where you may have a data edge.
Conclusion
Automated Market Makers are one of the most important and elegant innovations in the DeFi landscape. They are the decentralised engines that enable a truly peer-to-peer financial system, providing constant liquidity, enabling instant trades, and creating new opportunities for passive income.
By understanding how these clever algorithms leverage liquidity pools, you are well-equipped to navigate the exciting and ever-evolving world of blockchain finance — especially as platforms like Stellar continue to push the boundaries of what’s possible with innovations like Soroban.
Whether you're building the next great AMM or analyzing market trends, you need reliable data. The Hoops Finance Public AMM API offers real-time, structured data from across the Stellar and Soroban ecosystems, providing the insights you need to succeed. Access the API at hoops.finance.