Automated market maker

An automated market maker, or AMM, is a smart contract that lets people swap tokens without an order book or a human counterparty. Instead of matching a buyer with a seller, you trade directly against a pool of tokens that liquidity providers have deposited. The contract sets the price with a formula, and every swap moves that price a little.

The most common formula is the constant product rule: the two token balances in the pool are multiplied, and that product must stay the same after each trade. If you buy token A, you add token B to the pool and take token A out, so A becomes scarcer in the pool and its price rises. The larger your trade is relative to the pool, the further the price moves against you. Fees, often a fraction of a percent per swap, stay in the pool and are shared among the liquidity providers. Newer designs, such as concentrated liquidity, let providers pick a price range, but the basic idea is the same.

This matters because it is why almost any token can be tradable minutes after it is created. Anyone can create a pool and deposit two assets, and the contract will quote a price with no listing process. For small tokens, that also means the pool is often thin, so a purchase of a few thousand dollars can move the price by double digits. What you see as slippage is mostly this price impact, plus any price movement between the moment you submit a transaction and the moment it confirms.

Check the pool size before you buy, not just the market cap, since the real liquidity is what you can actually sell into. Look at whether the liquidity is locked or whether the creator can still withdraw it, because someone holding the pool tokens can drain it at any time. Be careful with tokens that have a transfer tax or a blacklist function, since an AMM will happily quote a price for a token you cannot sell. Also remember that large trades and bots that sandwich your swap can push the price around, so set a sensible slippage limit instead of accepting any amount.