Instead of using order books, DEXs rely on AMMs to determine prices dynamically. When traders swap one asset for another, the ratio of assets in the pool changes, affecting the price.

For example, in a BTC/USDC liquidity pool, if many traders buy BTC with USDC, the BTC supply in the pool decreases while USDC increases, causing the price of BTC to rise relative to USDC. This dynamic ensures that liquidity is always available and that prices adjust in real time based on market activity.

Here’s how this might work:

• Liquidity Providers (LPs) Supply Assets: Those who deposit assets into the pool are called LPs. They receive LP tokens, representing their share of assets in the pool.
• Liquidity Pools Adjust Pricing Algorithmically: The AMM ensures that as one asset is bought, its supply in the pool decreases, raising its price relative to the other asset.
• Arbitrage Keeps Prices Aligned: If the price of an asset in a DEX pool differs from another pool or a centralized exchange (CEX) like Coinbase, arbitrage traders step in to buy the underpriced asset and sell it elsewhere, helping align prices across markets.

To learn more about liquidity provisioning, explore our sections on:

• How Liquidity Provisioning Works
• Why Provide Liquidity?
• Liquidity Provisioning Risks & Considerations
• Liquidity Provisioning Popular Platforms