Automated Market Maker (AMM)

What Is an Automated Market Maker (AMM)?

They allow users to trade digital assets without the need for an intermediary. The rise of AMMs can be attributed to several factors, including their simplicity, affordability in terms of fees, and user-friendliness.

How Does an Automated Market Maker Work?

Here is an example of how an AMM works: 

• Consider a liquidity pool consisting of DAI and ETH. 

• If there’s a surge in demand for DAI, resulting in more ETH being deposited into the pool in exchange for DAI, an imbalance is created. 

• Consequently, ETH’s price is driven down due to its abundance in the liquidity pool.

The AMM’s formula sets prices from the pool’s own reserves, not from external markets. When the price of an asset in the pool diverges from its price on centralized exchanges, arbitrage traders step in to close the gap, trading against the pool until prices realign.

Automated Market Maker vs. Order Book

In practice, the lines between the two models are starting to blur. Some trading platforms now combine AMMs with order books in hybrid designs, and regulators have begun to address AMM-based systems directly.