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Automated market makers are a type of decentralized exchange protocol that determines the price of a token through formulas. These change with each protocol. There are different MAs that use different formulas, but they have one thing in common, which is that they all set prices through algorithms.
The operation of an AMM is similar to that of an order book exchange, i.e. it is not necessary to trust the trader because it is enough to interact with a smart contract . An AMM is a peer-to-peer transaction that involves exchanges between users and contracts.
A pool of liquidity occurs when users trade a huge amount of funds. When they provide cash, they get rewards for their transactions.
To calculate the price, a parabola-like formula will do this, where it shows that the slippage for small orders will be small and for large orders it will increase dramatically.
An impermanent loss occurs when a certain number of tokens appear and the relationship with the price changes after they are deposited. Depending on the change, the loss will be smaller or larger. For this reason, MAs have more optimal performance for stable currencies.
Losses can be recouped if the assets return to the same prices they had when the initial deposit was made. If, on the other hand, the investor withdraws his funds at a different ratio than the original one, these losses will be permanent.
Main advantages and disadvantages of MAs
On the one hand, some advantages of MAs are:
-Firstly, MMAs are decentralized, so there is no need for a central authority.
-There are no fees or admission criteria, anyone can create a cash pool for a token.
-Users don’t need to create any KYC accounts or verifications, so they only need their wallet address.
On the other hand, some of the disadvantages of MAs are:
-There is the possibility that users lose money due to interactions complicated by smart contracts, so AMMs may suffer from weaknesses or attacks.
-In order to correct the price of assets, arbitrage traders are essential in AMMs.
Conclusion of Automated Market Maker (AMM)
In conclusion, AMMs are necessary for the DeFi market, where anyone can easily and efficiently create markets. Although still under development, some like Uniswap and PancakeSwap are improving their platform and it is estimated that innovative MMAs will be created in the near future. What will provide DeFi users will be lower transaction fees and less liquidity.
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