AMM

The constant product formula, x·y=k, is the mechanism that removes the need for a counterparty. The pool always quotes a price because the ratio of its two reserves defines one. Trading moves that ratio, which moves the price, which is why execution worsens as trade size grows relative to pool depth. That relationship is deterministic and can be calculated before trading rather than discovered afterwards.

Liquidity providers deposit both assets and earn fees, and carry impermanent loss: when the external price moves, arbitrageurs rebalance the pool against them, leaving the provider with more of the depreciating asset. The loss is only impermanent if the price returns. Fees have to exceed it for provision to be profitable, which for volatile pairs is frequently not the case.

Concentrated liquidity, introduced by Uniswap v3, lets providers allocate capital to a price band instead of the whole curve. That improves capital efficiency substantially and converts passive provision into an active position that stops earning when price leaves the range. For an institutional desk the practical question is depth at the size being traded, not headline pool TVL. Explore the mechanics at the DeFi Primer.