What is an AMM?

An Automated Market Maker (AMM) is a type of decentralized exchange (DEX) protocol.

In traditional exchanges, a centralized orderbook matches the specific orders placed by buyers and sellers, and this is usually facilitated by an intermediary. Unlike traditional exchanges, AMMs use smart contracts on the Solana blockchain to enable traders to trade against the tokens deposited in a liquidity pool.

For liquidity providers (LPs): In an AMM, LPs deposit different token asset pairs into liquidity pools so traders can trade against those tokens. In the most common constant product-based AMM, each token in the pair being deposited are usually of equivalent $USD value (50:50). For example, LPs can deposit an equivalent value of SOL and USDC into a SOL-USDC liquidity pool.

For traders: A trader or another smart contract can then interact directly with the AMM pool smart contract to swap one token for the other. For example, using SOL to swap for USDC in a SOL-USDC pool. This process can be done automatically on the blockchain with the exchange rate calculated based on a pre-defined mathematical formula and accounting for the available tokens in the pool. Hence the AMM can facilitate trades in a non-custodial, decentralized manner without an intermediary.

LP Fees: When trades are completed by utilizing the tokens in the liquidity pool, liquidity providers of that pool earn a portion of the fees based on their share of the total liquidity in the pool.

An example of such an AMM in operation is Meteora's Dynamic AMM.