💱 DeFi & Tokens
DEXs & Liquidity Pools
How you can swap tokens with no order book and no broker.
7 min read
Swapping without a counterparty
A traditional exchange matches a buyer with a seller. A decentralized exchange (DEX) often skips the match entirely. Instead, you trade against a pool of tokens held by a smart contract - an automated market maker.
Liquidity providers deposit two assets into the pool. A formula (classically x · y = k) sets the price based on the ratio in the pool. Your swap shifts that ratio, which is why large trades move the price - an effect called slippage.
Where the yield comes from
Every swap pays a small fee that goes to the liquidity providers. That's their reward for supplying the assets others trade against.
But providing liquidity isn't risk-free. If the two assets' prices diverge, a provider can end up worse off than simply holding them - a phenomenon called impermanent loss.
More liquidity in a pool means less slippage - big trades barely move the price when the pool is deep.
Check your understanding
3 questions from this lesson, with the correct answer already marked.
1. On an AMM-based DEX, who is your trade matched against?
- Another individual trader
- A liquidity pool held by a smart contract
- A central bank
- A broker
You trade against a pool of assets priced by a formula, not against a matched counterparty.
2. Why do large trades move the price on an AMM?
- The exchange charges more for big trades
- They shift the ratio of assets in the pool, which sets the price
- Validators vote on each price
- Gas fees change the price
Price comes from the pool ratio, so a big swap changes that ratio - the effect known as slippage.
3. How do liquidity providers earn a return?
- A share of the swap fees
- Interest from a bank
- Mining rewards
- Government subsidies
Each swap pays a fee that is distributed to the pool's liquidity providers.