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Constant function market maker
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<p>Constant-function market makers (CFMM) are a paradigm in the design of trading venues where a trading function and a set of rules determine how liquidity takers (LTs) and liquidity providers (LPs) interact, and how markets are cleared. The trading function is <a href="/facts/Deterministic/NhvNlAbe">deterministic</a> and known to all market participants. </p><p>CFMMs display pools of liquidity of two <a href="/facts/Assets/o7TARXhB">assets</a>. The takers and providers of liquidity interact in the liquidity pools: LPs deposit their assets in the pool and LTs exchange assets directly with the pool. CFMMs rely on two rules; the LT trading condition and the LP provision condition. The LT trading condition links the state of the pool before and after a <a href="/facts/Trade/S13U8JKr">trade</a> is executed, and it determines the relative <a href="/facts/Prices/yWQ8edfN">prices</a> between the assets by their quantities in the pool. The LP provision condition links the state of the pool before and after liquidity is deposited or withdrawn by an LP. Thus, the trading function establishes the link between liquidity and prices, so LTs can compute the execution costs of their trades as a function of the trade size, and LPs can compute the exact quantities that they deposit. In CFMMs, both conditions state that <a href="/facts/Price_formation/SfjzyX6C">price formation</a> happens only through LT trades (see below). </p><p>In <a href="/facts/Decentralized_finance/xjvIyL8f">decentralized platforms</a> running on <a href="/facts/Peer-to-peer/wCCdPb0H">peer-to-peer</a> <a href="/facts/Computer_network/3w5RM99p">networks</a>, CFMMs are hard-coded and immutable <a href="/facts/Computer_program/e38jH9N9">programs</a> implemented as Smart Contracts, where LPs and LTs invoke the code of the contract to execute their transactions. A particular case of CFMMs are the constant product market makers (CPMMs) such as <a href="/facts/Uniswap/hEUQ9vpt">Uniswap</a> v2 and Uniswap v3 where the trading function uses the product of the quantities of each asset in the pool to determine clearing prices. CFMMs are also popular in prediction markets. </p>