What is the role of Automated Market Maker in DeFi?

 

What Is an Automated Market Maker?

Automated Market Maker is a mechanism that executes the trading of digital assets without any permission and trade executes automatically with the use of liquidity pools that replaces buyers and sellers.

It is a type of decentralized exchange (DEX) protocol that relies on the mathematical formula to set the price for the assets. This formula is the replacement of order books in traditional exchanges where the price of the assets is determined by pricing algorithms.

Before the arrival of Automated Market Making

Before the arrival of Automated Market Makers, the Cryptocurrency Exchange Globe was ruled by "Order Books". The Order book is nothing but a mechanism that lists all the buy and sell orders which replicate the price and quantity of the crypto assets.

The matching of buyer and seller orders eats some valuable time of the traders and also has some major issues such as slippage and latency in the price discovery & more.

The major issue of the Order Book mechanism is the news that highlighted in the newspaper about Market Makers like Nasdaq and NYSE, which created an unsafe environment for human market makers.

Early Stages of Automated Market Making

The first financial organization that utilizes automated market-making was Shearson Lehman and Brothers. This technology was simple and it is to reduce the chances of any human errors and bring high liquidity to the market.

This automated market maker algorithm works according to " if this then that", this means that it takes an action if the price of an asset moves up or down. Since Automated Market Maker is quite complicated, this involves the math formula to calculate the price of the assets.

Since, this Automated Market Maker technology benefits most of the traders and companies, since one should pay a commission fee if there is winning or losing.

How Does Automated Market Maker Work?

An Automated Market Maker works like order books in any exchanges that are trading pairs. But you don't need to have a counterparty on the other side to finish your trade. Instead, you will be interacting with smart contracts, which automate the trade and makes a market for you.

On many decentralized exchanges, the Automated Maker Model is preferred for trading cryptocurrencies. 

In Binance DEX, the trading happens directly between user wallets which do not involve any need of buyer or seller.

Get to know more about Automated Market Maker, AMM in DeFi space -> What is Automated Market Maker (AMM)?