What is an Automated Market Maker (AMM)?
Automated Market Maker (AMM) is a decentralized platform that uses algorithms to determine the price of assets and provide liquidity to the market. Unlike traditional exchanges, which rely on order books and human intervention, AMMs use mathematical formulas to calculate the price of assets based on supply and demand. This eliminates the need for intermediaries and provides a more transparent, secure, and efficient way to trade cryptocurrencies and other assets.
AMMs work by creating a pool of assets and using a mathematical formula to calculate the price of each asset. The formula takes into account the amount of each asset in the pool, as well as the total value of the pool, to determine the price of each asset. When a user wants to trade an asset, they provide the asset to the pool in exchange for another asset, and the price is automatically calculated based on the formula.
One of the benefits of AMMs is that they provide liquidity to the market, even in cases where there may be a lack of buyers or sellers. This is because the AMM algorithm is designed to automatically balance the supply and demand of assets, ensuring that trades can always be executed. Additionally, AMMs are decentralized, meaning that there is no central authority controlling them. This eliminates the risk of manipulation and provides a more secure and transparent platform for trading.
Another benefit of AMMs is that they provide access to a wider range of assets, including illiquid assets that may not be traded on traditional exchanges. This opens up new investment opportunities for users and provides greater access to the financial markets. Additionally, AMMs typically have low trading fees and do not require a minimum deposit, making them accessible to a wider range of users.
Simplified Example
An Automated Market Maker (AMM) can be thought of as a robot store owner. Imagine a store that automatically sets the price of its items based on supply and demand, just like how an AMM sets the price of assets in a market. The store owner, who is the robot in this case, does not have to manually change the prices of each item, it does so on its own based on how many people want to buy or sell that item. Similarly, an AMM sets the price of an asset based on the supply and demand in the market, creating a fair and efficient system.
History of the Term "Automated Market Maker (AMM)"
The exact origin of the term "Automated Market Maker (AMM)" remains uncertain, but its application can be traced back to the early 2010s with the rise of decentralized exchanges (DEXs) in the cryptocurrency sphere. The term likely emerged to characterize a novel form of decentralized exchange mechanism, leveraging liquidity pools and algorithms to facilitate trades between users independently of traditional market makers. One of the earliest instances of the term "Automated Market Maker" is documented in a 2016 whitepaper titled "Bancor: A Protocol for Liquidity-Based Token Exchange" by Eyal Hertzog and Shai Halevi. In this whitepaper, they introduced the Bancor concept, an innovative DEX employing an AMM mechanism to handle liquidity and establish pricing for token pairs.
Examples
Uniswap: Uniswap is a decentralized automated market maker (AMM) platform built on the Ethereum blockchain. It allows users to trade cryptocurrencies without the need for an intermediary, by automatically determining the price of assets based on supply and demand. Uniswap uses a mathematical formula, known as a constant function market maker (CFTM), to calculate the price of assets and provide liquidity to the market. The platform is completely decentralized, meaning there is no central authority controlling it.
Balancer: Balancer is another decentralized automated market maker platform that allows users to trade cryptocurrencies and other assets. It uses a multi-asset pool system to provide liquidity, where users can deposit multiple assets into a pool and earn a share of the trading fees. The platform also offers advanced features, such as the ability to create custom pools with different weightings for each asset and the ability to set custom trading fees.
Bancor: Bancor is a decentralized liquidity network that uses automated market making to provide liquidity to users. The platform allows users to trade a variety of assets, including cryptocurrencies, stablecoins, and tokenized assets, without the need for an intermediary. Bancor uses a mathematical formula, similar to Uniswap, to calculate the price of assets and provide liquidity. Unlike traditional exchanges, Bancor operates 24/7 and does not have a central point of control or failure, making it a more resilient and secure platform for trading.
Related Terms
Decentralized Exchange: A type of cryptocurrency exchange that operates on a decentralized platform, meaning that it is not controlled by a single entity.
Market Maker/Market Taker: Terms used to describe the two main types of participants in a financial market.