DEXs & Liquidity Pools
How you can swap tokens with no order book and no broker.
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.
Remember
More liquidity in a pool means less slippage - big trades barely move the price when the pool is deep.
Self-check
Check your understanding
Try each question before opening the answer.
On an AMM-based DEX, who is your trade matched against?
- A.Another individual trader
- B.A liquidity pool held by a smart contract
- C.A central bank
- D.A broker
Reveal answer
B. A liquidity pool held by a smart contract
You trade against a pool of assets priced by a formula, not against a matched counterparty.
Why do large trades move the price on an AMM?
- A.The exchange charges more for big trades
- B.They shift the ratio of assets in the pool, which sets the price
- C.Validators vote on each price
- D.Gas fees change the price
Reveal answer
B. They shift the ratio of assets in the pool, which sets the price
Price comes from the pool ratio, so a big swap changes that ratio - the effect known as slippage.
How do liquidity providers earn a return?
- A.A share of the swap fees
- B.Interest from a bank
- C.Mining rewards
- D.Government subsidies
Reveal answer
A. A share of the swap fees
Each swap pays a fee that is distributed to the pool's liquidity providers.
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