Traditional exchanges match buyers to sellers through an order book. Automated market makers replace that with a pool: two tokens locked in a smart contract, priced by a formula instead of by order matching.
The classic formula is x times y equals k — the product of the two token reserves stays constant. When you buy token A from the pool, you add token B and remove token A, which shifts the ratio and therefore the price. Bigger trades shift the ratio more, which is why slippage exists.
Liquidity providers deposit both sides of the pool and earn a share of trading fees proportional to their contribution. The catch is impermanent loss: when the price of one token moves relative to the other, the pool's automatic rebalancing leaves LPs holding more of the depreciating asset. Fees can outweigh that loss in high-volume pools, or not.
Concentrated liquidity designs (like Orca Whirlpools) let LPs specify a price range, dramatically increasing capital efficiency — and the risk that the position goes out of range and stops earning.
Pools are infrastructure, not investments in themselves. Understanding them explains why prices move when you trade, why deep pools matter, and where DEX fees actually go.
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