What is Automated Market Maker (AMM) ?

AMM systems were first introduced in the early 1990s by Shearson Lehman Brothers and ATD. AMMs have become the primary means of trading assets in the DeFi ecosystem, and it all started with a blog post by Vitalik Buterin, the founder of Ethereum, about "on-chain market makers." Automated market makers (AMMs) are part of the decentralized finance (DeFi) ecosystem. They allow unauthorized and automated trading of digital assets using liquidity pools instead of a traditional buyer and seller platform. AMM users provide liquidity pools with crypto tokens whose prices are determined by a fixed mathematical formula. In the AMM system, liquidity pools can be optimized for different purposes, thus proving to be a very important tool in the DeFi ecosystem.
Instead of relying on traditional buyers and sellers in a financial market, AMMs keep the DeFi ecosystem liquid 24/7 through liquidity pools. In a traditional platform, buyers and sellers offer different prices for an asset. When other users find a listed price acceptable, they trade, which becomes the market price of the asset. Most stocks, gold, real estate and other assets rely on this traditional market structure for trading. However, AMMs have a different approach to asset trading. AMMs are a financial tool specific to Ethereum and decentralized finance (DeFi). This new technology is decentralized, always open for trading, and does not rely on the traditional interaction between buyers and sellers. AMM, the new method of exchanging assets, embodies the ideals of Ethereum, crypto and blockchain technology in general, allowing everyone to participate in the system by developing new solutions without anyone's control.
On AMM-based decentralized exchanges, the traditional order book is replaced by pre-funded liquidity pools on-chain for both assets of the trading pair. Liquidity is provided by other users who earn passive income from their deposits through transaction fees based on the percentage of the liquidity pool they provide. An example of a decentralized exchange that implements an AMM system is Uniswap. Uniswap is an Ethereum-based decentralized exchange that allows its users to both provide liquidity to earn passive income and exchange between various assets.