Constant Product Market Maker (CPMM)

An automated pricing model in DeFi that maintains a constant product of asset reserves in a liquidity pool to determine prices.

What is Constant Product Market Maker (CPMM)?

The Constant Product Market Maker (CPMM) is the foundational algorithm for many decentralized exchanges, governed by the formula x * y = k, where x and y are the quantities of two assets in a pool, and k remains constant during trades. Pioneered by Uniswap, this model allows users to trade directly against the pool without needing counterparties, with prices adjusting based on reserve ratios. For example, in an ETH/USDC pool with 1,000 ETH and 4,500,000 USDC (k=4,500,000,000), swapping 10 ETH requires depositing about 45,454.55 USDC, resulting in an effective price of 4,545.45 USDC per ETH.

CPMMs excel in spot trading for digital assets, facilitating over $2 trillion in cumulative volume on Uniswap alone, but struggle with perpetual futures due to oracle dependencies and lack of precise price discovery. They distribute liquidity across an infinite price range, leading to inefficiencies where most capital sits idle, as seen in stablecoin pairs like USDC/DAI trading tightly around $1.

Evolutions like Uniswap v3 address some limitations through concentrated liquidity, but core CPMM mechanics remain vulnerable to impermanent loss, where arbitrageurs rebalance pools after external price changes, often leaving providers with more of the depreciating asset. Platforms like SushiSwap and Balancer also employ CPMM variants, supporting multi-asset pools for enhanced flexibility in DeFi.