Decentralized exchanges price assets differently from anything traders encounter on centralized platforms. No order book, no market maker on the other side of your trade, and no human deciding what a token is worth at any given moment. Instead, a mathematical formula governs every swap, and a class of participants known as arbitrageurs keeps those prices roughly in line with the rest of the market. Below, we quickly explain how it works — should prove handy for anyone who wants to use DeFi regularly or just to evaluate protocols more rigorously.

What an Automated Market Maker Actually Does

A traditional exchange matches buyers with sellers. Someone posts an offer to sell at a given price, someone else agrees, and the trade settles. A DEX running an automated market maker replaces that process entirely. Instead of matching counterparties, traders swap against a pool of tokens held in a smart contract.

The pool holds two assets, and the ratio between them determines the price. The most widely used formula is the constant product model, expressed as:

• X multiplied by Y equals K,
• where X and Y represent the quantities of each token in the pool,
• and K is a fixed constant.

Every time a trade occurs, the token ratio shifts, which moves the price. Buy more of token A, its quantity in the pool falls, and its price relative to token B rises. The formula adjusts automatically, with no human input required.

This structure has a practical consequence that catches new DeFi users off guard. The AMM does not update its prices based on external market information. Prices in the pool only change when someone trades against it. If a token surges on a centralized exchange and the AMM pool has not seen recent activity, it will briefly offer that token at a stale, lower price. That gap is where arbitrage enters.

How Arbitrageurs Keep DEX Prices Accurate

Arbitrage stands for exploiting price differences across markets. In DeFi, this mechanism is what keeps AMM prices from drifting permanently away from global market rates. Arbitrageurs continuously compare prices across DEXs and centralized exchanges, often through automated bots.

When a gap appears, they buy the underpriced token from the AMM pool and sell it elsewhere. This pushes the pool ratio back toward equilibrium. Once the price difference no longer covers the cost of the trade, the arbitrage opportunity closes.

This system has real limitations. Arbitrage depends on network conditions. When transaction fees are high or the network is congested, arbitrageurs may hold back because the cost of executing the trade exceeds the available profit. During those windows, AMM prices can deviate from the market for longer than usual. Liquidity pools with thin liquidity are also more susceptible to price manipulation by large traders, who can move the pool price significantly with a single large swap.

How the Underlying Network Shapes This Dynamic

The network a DEX runs on directly affects how efficiently the arbitrage operates. On Ethereum, arbitrageurs compete to include transactions in the next block. This competition creates maximal extractable value (MEV), where bots pay higher fees to get their transactions ordered ahead of others.

Hedera uses a hashgraph consensus mechanism that enforces fair transaction ordering. Because no participant can pay to jump the queue, MEV does not apply in the same way it does on Ethereum-based networks. Transaction finality on Hedera settles in 3 to 5 seconds, and fees are fixed in USD (instead of fluctuating with network demand), which gives traders and liquidity providers predictability around execution costs.

Among the DEX protocols, SaucerSwap has established itself as a leader on the Hedera network for token swaps and liquidity provision. It runs two parallel systems:

• V1 uses a standard constant product AMM,
• V2 introduces concentrated liquidity, allowing providers to allocate capital within specific price ranges for better capital utilization.

The dual structure lets passive and active participants choose the model that fits their approach.

Because Hedera processes transactions at low, predictable costs, the arbitrage window on AMMs like SaucerSwap closes faster than it might on chains with high fees that slow arbitrageurs’ responses.

Concentrated Liquidity and Why It Changes the Calculation

Standard AMMs spread liquidity across all possible prices, from zero to infinity. Most of that capital sits far from where the token actually trades, earning nothing. Concentrated liquidity, introduced by Uniswap v3 and since adopted by other protocols, lets liquidity providers define a specific price range for their capital. Within that range, the capital is far more active and generates more fees per dollar deployed.

The trade-off is complexity. If the token price moves outside the chosen range, the position earns no fees, and the provider holds only one of the two assets. Passive LPs who do not want to monitor positions regularly are often better served by standard pools. Active participants who understand the mechanics and are willing to manage their ranges can achieve meaningfully better capital efficiency, though the risk of being caught outside the range is real and worth factoring into any decision.

Price Impact, Slippage, and What TVL Actually Tells You

Even under normal conditions, large trades on AMMs carry a cost that smaller trades do not. When you buy a meaningful quantity of any token from a pool, you shift the ratio noticeably. The price you pay for the last unit of the trade is worse than the price you paid for the first. Slippage scales with both trade size and pool depth:

A pool with deep liquidity can absorb a large trade with minimal price movement.
A pool with shallow liquidity will move significantly on a trade that would barely register on a major centralized exchange.

Traders on AMMs sometimes split large orders into smaller pieces over time to reduce average slippage. Others rely on tools that route trades across multiple pools automatically to find the most efficient execution path. The altFINS DEX Aggregator works on this principle, scanning available liquidity across venues to optimize execution for traders who want the best available price.

This is why TVL matters as a practical metric and not just a headline number. More locked liquidity means less slippage for the same trade size. When evaluating any DEX, including protocols building on newer networks, TVL trends and fee revenue are more telling than marketing claims.

A Few Risks to Keep in Mind

AMM liquidity provision carries real trade-offs. Impermanent loss occurs when the price ratio between your two deposited tokens shifts, leaving you with less of the appreciating asset than if you had simply held it. Smart contract vulnerabilities are another consideration, since audits reduce risk but do not eliminate it. Tracking on-chain data, pool depth, and fee revenue gives a clearer picture of protocol health than price alone and helps you assess the real cost of any trade before committing capital.