Automated Market Maker List

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AMM List: What Is an Automated Market Maker?

AMM is a software algorithm that provides instant transactions and automatic regulation of the price of assets in the liquidity pool.

The automated market maker replaced a system in which all orders were placed manually in the order book and analyzed by the exchange staff in search of matches. This approach was severely limited in efficiency and speed. In modern centralized exchanges, it is often the bidders themselves who look through the order book, select suitable offers from the list.
In the field of cryptocurrencies, AMMs are commonly used in exchange services on decentralized exchanges. 

How Does It Work? 

Liquidity providers enter two currencies into the system for the same amount in dollar terms in the so-called pools. From that moment on, the algorithm manages the money.

The pool client makes an application for an exchange at a rate that suits him with a small percentage of admission. It sends one coin and, as soon as there is liquidity in the system on suitable conditions, it receives back the necessary tokens at the AMM internal rate with a commission fee.

Important! The situation when the price of an order increases during the search for liquidity or confirmation is called slippage.

When the volume of one of the currencies in the pool begins to decrease, the market maker raises its value and lowers the second. Thus, the overall balance of assets is maintained. There are more complex algorithms that align several pairs of tokens at once.

Liquidity providers can withdraw their investments at any time along with the commission earned. At the same time, the output assets may not quantitatively coincide with the deposit (one more, the other less), but the total value of the pair will be preserved.

Varieties of Automated Market Makers

There are the following types of smart contracts for automated trading:

CFMMs or Constant Function Market Makers. It is one of the most common varieties, because it was created specifically for projects from the DeFi (decentralized finance) sphere. 

The main feature is permanent functionality, implemented thanks to the work of smart contracts. At the same time, there is no need to enter data into the order book or send it to the second party. The value of the assets in the pool is regulated by external smart contracts.

CPMM or Constant Product Market Maker. In this model of the algorithm, the option of automated regulation of price ranges has appeared. This requires stable liquidity in two directions and four currencies at once. It is regulated by a simple formula – the amount of the first asset, multiplied by the amount of the second, must be unchanged (a x b = const). If the volume of stocks of one of them grows, then the price automatically decreases.

CMMM or Constant Mean Market Maker. The most complex algorithm that allows you to process 3 or more cryptocurrency pairs simultaneously. It is possible to fine-tune the average weight in addition to the standard 50 by 50. The constant for the three directions is calculated by the formula (a x b x c) ^ 1/3.

Using new models of algorithms, even in relation to unstable coins, AMMs can offer rates that are superior to those offered by centralized exchanges.

AMM Advantages and Disadvantages

The advantages of an automated market maker are as follows: 

Strong slip reduction.

Holding orders for no more than a second.

High speed and low maintenance.

Great liquidity in various markets.

The other side of the transaction (the seller) does not need to be online.

Smoothing sharp price fluctuations.

Protection against price manipulation (pump, dump, etc.)

Increase in net profit.

Attracting new investors.

The cons are listed below: 

Multicurrency exposure. Liquidity providers need to invest at least two currencies, one of which will always be less reliable than the other. The risks increase and the possible income decreases compared to investing in one asset.

Impermanent losses. Due to the growth of the exchange rate of one token relative to another, the total withdrawal amount may turn out to be less than if the money simply lay on the wallet. The reason for this is the mechanisms of automatic regulation and the actions of arbitrageurs.

Low return on investment. To minimize slippage as much as possible, you need to invest the largest possible amount, which in the end will still not be fully used.

AMM Application Beyond Cryptocurrencies

Similar principles of work can be seen in Forex, which is a multi-level system of orders for transactions with fiat currencies. Since 90% of traders occupy the lowest level in the system, they need intermediaries. Among them there are so-called dealing centers. They use up-to-date world quotes, but all traders' orders are cooked inside the system itself, without entering the external market. Honest brokers add up all orders for the sale and purchase of each currency, while the difference is displayed in the interbank market. This automatic algorithm is called matching.

In the world outside the blockchain, the old principles of market making are mainly used, when transactions are carried out in manual or semi-automatic mode. The problem of low or no liquidity is not so acute here, so new algorithms are not in great demand compared to the DeFi sector.