More and more people are becoming interested in crypto assets. When participating in the crypto markets, finding an exchange you can trust and rely on is essential. An exchange connects buyers and sellers of different cryptocurrencies. These exchanges need to maintain a stable marketplace by having a large pool of liquidity providers, otherwise known as cryptocurrency market makers. Let’s take a look at how automated market makers are impacting crypto trading in this article.
What are Automated Market Makers?
An automated market maker (AMM) is an industry term for a computer program that automatically purchases and sells assets to ensure sufficient liquidity in the market.
The main benefit of using an AMM in crypto is its ability to reduce the spread between an asset’s bid and ask price. AMMs also contribute to greater liquidity because they continually buy and sell assets. Even when market volumes are low, this constant activity may ensure that there will always be someone to buy or sell an asset.
However, traders should know that AMMs carry a few risks:
- AMMs can have bugs or errors since they are smart contracts. There’s a chance a bug could affect the prices of the assets an AMM trades, potentially making traders lose money.
- The decision-making process for AMMs is often based on complex algorithms. AMMs could make poor trading decisions if the algorithms are not properly designed.
- To function effectively, AMMs need a lot of money. AMMs with insufficient capital may have to sell assets at a loss to meet their liquidity needs. Traders need to research an exchange before trading cryptocurrencies with it.
AMMs can be a valuable tool for traders seeking to participate in cryptocurrency markets, even with the risks involved. The right use of these instruments can help reduce spreads and provide liquidity. However, it is important to remember that AMMs are still computer programs, and as such, they cannot be completely flawless. When trading cryptocurrencies, traders should always conduct their own research before using an automated market maker.
AMMs vs. Centralized Exchanges
Smart contracts are a key feature that separates AMMs from centralized exchanges. Smart contracts allow AMMs to execute trade orders automatically instead of manual matching on centralized exchanges. It can decrease the likelihood of errors and speed up the trading process.
There is another important difference between AMMs and centralized exchanges regarding handling order book data. Order book data is often hidden in AMMs, as opposed to centralized exchanges where it is available to all users. Due to this secrecy, traders will not be able to view the order book data in advance, which can help prevent the practice of exploiting not-executed trades for profit.
How AMMs are Used in DeFi
AMMs are widely used in decentralized finance (DeFi). Blockchain-based financial services are at the core of DeFi, a rapidly growing sector within the cryptocurrency industry. The DeFi platforms that use AMMs range from lending and borrowing platforms to stablecoin exchanges and derivative platforms.
AMMs can reduce the risk of counterparty default in DeFi, which is one of their major benefits. All the trades that are executed on an AMM make use of smart contracts to facilitate the exchange of funds. Because the terms of trade are encoded, trust between counterparties is unnecessary. Whenever one party fails to fulfill its obligation, the smart contract will automatically execute the trade and transfer the assets to the other party.
Also, the liquidity AMMs provide can benefit low-volume markets. AMMs are always buying and selling assets, even when there are no traders on the market, which is why they are so effective. A constant flow of activity ensures that someone is always to trade a particular asset, regardless of how busy the market may be.
An AMM’s Future
There is no doubt that AMMs offer traders and exchanges many benefits. There are several advantages AMMs possess over traditional centralized exchanges, which will likely prompt more exchanges to use them in the future. AMMs will also find even more use in DeFi in the future since they’re good at providing liquidity and reducing counterparty risk.
AMMs will probably undergo some improvements as their use grows. For example, new algorithms may be developed to better manage liquidity and reduce spreads. Moreover, new features may be introduced, such as the capability to trade directly from an order book.
Whatever the future brings for AMMs, they will significantly impact the cryptocurrency industry.
Some Examples of Popular Automated Market Makers
There are many cryptocurrency exchanges worldwide, but Binance appears to be the largest and most popular. Binance Coin, Ethereum, Litecoin, and Bitcoin are among the major cryptocurrencies available on this AMM exchange.
There is a decentralized exchange version of Binance called Binance DEX. A big difference between Binance DEX and Binance is that Binance DEX is based on the Binance Chain blockchain, while Binance is based on Ethereum. The Binance DEX can conduct transactions at a faster and more affordable rate as a result of this.
The Uniswap protocol can be used to build decentralized exchanges on Ethereum. A smart contract system facilitates the automatic matching of orders and the execution of trades. In the world of DeFi, Uniswap is one of the most popular protocols due to its simplicity and high level of liquidity.
Using Ethereum’s blockchain, Kyber Network facilitates cryptocurrency trading. Trades are executed automatically on the protocol, thanks to smart contracts. A large number of digital assets are supported by Kyber Network, making it a popular choice for those interested in trading a wide array of assets.
These are just a sampling of several popular AMM exchanges currently available in the market. We will likely see even more exchanges emerge in the future as the use of these platforms increases.
Traditional centralized exchanges have several disadvantages compared with AMMs. In addition to providing liquidity to low-volume markets, AMMs reduce counterparty default risk. Additionally, with smart contracts, transactions can be completed quickly and cheaply. No doubt, as the use of AMMs grows, more exchanges will move toward implementing this kind of technology.