DeFi Fundamentals Series: Automated Market Makers

Geoffrey Miller
Geoffrey Miller
DeFi Fundamentals Series: Automated Market Makers
Table of Contents
Table of Contents

AMMs are a great tool to use for trading. They are invaluable in traditional financial contexts and absolutely essential to DeFi. But, what exactly are they?

In this new series of posts, I will be introducing important ideas in DeFi. My goal will be to demystify some of the harder concepts with which many readers struggle. And, few topics in cryptocurrency can be as confusing as automated market makers. Thus, that seems like a great place to start!

What is an Automated Market Maker?

As defined by the US Securities and Exchange Commission (SEC), automated market makers (AMMs) are software tools that use algorithms to trade stocks, futures, and other financial assets without human intervention.

AMMs have actually been around for quite a while. They took off during the early 1990s when Shearson Lehman Brothers and ATD first implemented them. In both DeFi and more traditional financial contexts, AMMs are designed to ensure a continuous flow of orders. They provide two-way quotes so that investors can trade without taking any breaks. This is done in all market conditions to secure the best prices for trading.

What are the Benefits of Automated Market Makers?

Automated trading platforms come with a variety of features such as pre-built strategies, technical indicators, and trading alerts. These features allow traders to automate their trades and make decisions on when to buy or sell stocks based on an algorithm's analysis, which can be less prone to error than human judgment. For example, AMMs avoid slippage and latency in price discovery on the markets, which is otherwise practically inevitable with manual order book models where humans keep track of buy and sell activities and set prices and place bids.

Other benefits of AMMs include:

  • Increased Efficiency: Automated trading software can be programmed to take advantage of price discrepancies in the market by buying low and selling high. This can provide more profit opportunities than a human trader would be able to find in a given time period.
  • Reduced Risk: Automated market makers also allow traders to set stop losses so that if their trades go against them they will be able to pull out and prevent unacceptable decreases in total value.
  • Low Fees: AMMs offer low fees for traders, as the system's upkeep costs are minimal. There is no need to pay human market makers nor the support staff they require to function.
  • Enhanced Liquidity: Thanks to computer optimization and continual operation, AMMs offer more liquidity than traditional exchanges, which can be a huge boon for traders. Moreover, AMM's liquidity pools enable trades without the presence of counterparties.
  • No Third-Parties: AMMs offer a more efficient alternative to traditional order book exchanges and allows users to trade digital assets without an intermediary, human or otherwise.

This last benefit is the main reason why AMMs are crucial to decentralized finance (DeFi). After all, decentralization is all about cutting out third-parties and restricting interactions to direct peer-to-peer exchanges whenever possible.

What Role do Automated Market Makers Play in DeFi?

Automated Market Makers (AMMs) make trading simple on decentralized exchanges like InfinitySwap. They use advanced algorithms to match the prices of buyers and sellers so they can do trades. This means that users can purchase and sell digital assets in a trust-less, peer-to-peer fashion without relying on a custodian service or other third party.

Moreover, with an AMM, there is no manual price setting. Liquidity pools take care of it automatically, adjusting as needed to the ebb and flow of supply and demand. That helps ensure fair prices that reflect current value.

AMMs Supercharge DeFi

In conclusion, AMMs are a great tool to use for trading. They are invaluable in traditional financial contexts and absolutely essential to DeFi. With the help of AMMs, traders can find the best entry and exit point in a given market. With all of the tools available to traders that are associated with AMMs, they can make more informed decisions and improve their trading skills.

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  • Disclaimer: The views and opinions expressed on this website are solely those of the original author and other contributors. These views and opinions do not necessarily represent those of the Dfinity Community staff and/or any/all contributors to this site.

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