On-chain Pricing

First made popular by Uniswap in 2018, on-chain pricing is used by automated market makers to decide on the price of an asset in a swap. In a nutshell, users are not trading against each other – instead, they are trading against the liquidity locked inside smart contracts called liquidity pools.

Preset mathematical equations are used to set relationships between the assets held in the liquidity pools. When large orders are placed in AMMs, a sizable amount of a token is removed or added to a pool. This causes discrepancies between the asset’s price in the pool and its market price at different exchanges, creating an arbitrage opportunity.