Automated Market Makers (AMMs) are a type of decentralized exchange (DEX) mechanism that enables trustless trading of digital assets without the need for traditional order books. Instead of relying on buyers and sellers to match orders, AMMs use mathematical formulas and liquidity pools to determine asset\u00a0prices.<\/p>\n
AMM Mechanism<\/p>\n
The flowchart above outlines the AMM process<\/strong>, which consists of two primary user actions: trading<\/strong> and providing liquidity<\/strong>.<\/p>\n Users can either trade assets<\/strong> or provide liquidity<\/strong> to the\u00a0pool.<\/p>\n If a user chooses to provide liquidity<\/strong>, they must deposit token pairs<\/strong> into a liquidity pool<\/strong>.These liquidity pools operate under a constant product formula<\/strong>, such as x*y=k\u00a0, ensuring that the pool maintains balance.<\/p>\n If a user wants to trade<\/strong>, they submit their tokens to the pool, triggering a smart contract<\/strong> that governs the exchange.The AMM applies the constant product formula<\/strong> to determine the trade price dynamically.<\/p>\n The trade type is identified as either a swap (exchange one token for another)<\/strong> or liquidity removal<\/strong> (withdrawal of tokens by liquidity providers).<\/p>\n If swapping:<\/p>\n The output amount<\/strong> is calculated based on the AMM\u00a0formula.The trade is executed, and pool balances are\u00a0updated<\/strong>.<\/p>\n If removing liquidity:<\/p>\n Tokens are returned to the provider<\/strong>, and the corresponding liquidity pool (LP) tokens are burned<\/strong> to adjust the total liquidity.<\/p>\n Here are some of the AMM Formulas used for the exchange purposes:<\/p>\n Constant Product Market Maker is the most common AMM model used, popularized by Uniswap, is the Constant Product Market Maker. It follows a simple yet powerful mathematical principle:<\/p>\n x * y =\u00a0k<\/p>\n Where:<\/p>\n x: quantity of token X in the\u00a0pooly: quantity of token Y in the\u00a0poolk: constant product\u00a0valueCPMM Graph<\/p>\n Let\u2019s say we have a pool\u00a0with:<\/p>\n 100 ETH\u00a0(x)200,000 USDC\u00a0(y)k = 100 * 200,000 = 20,000,000<\/p>\n If someone wants to buy 10 ETH, we can calculate the required USDC\u00a0using:<\/p>\n (100\u201310) * (200,000 + \u0394y) = 20,000,00090 * (200,000 + \u0394y) = 20,000,000200,000 + \u0394y = 20,000,000\/90\u0394y = 22,222.22 USDC<\/p>\n This means they need to pay 22,222.22 USDC for 10 ETH, resulting in a price impact due to the size of the\u00a0trade.<\/p>\n A simpler model that maintains a constant sum of\u00a0assets:<\/p>\n x + y =\u00a0k<\/p>\n While this appears simpler, it has a major limitation: it provides infinite liquidity at a constant price, which isn\u2019t sustainable in practice. This is why it\u2019s rarely used in isolation.<\/p>\n CSMM Graph<\/p>\n With a pool\u00a0of:<\/p>\n 100 ETH + 200,000 USDC = 200,100\u00a0(k)Price is fixed at 2,000 USDC per\u00a0ETHNo price impact regardless of trade\u00a0size<\/p>\n Balancer introduced this generalized form that allows for multiple tokens with different weights:<\/p>\n (x\u2081^w\u2081) * (x\u2082^w\u2082) *\u00a0\u2026 * (x\u2099^w\u2099) =\u00a0k<\/p>\n Where:<\/p>\n x\u1d62: quantity of token\u00a0iw\u1d62: weight of token\u00a0i\u03a3w\u1d62 =\u00a01CMMM Maker<\/p>\n For a pool\u00a0with:<\/p>\n 80% USDC (w\u2081 =\u00a00.8)20% ETH (w\u2082 =\u00a00.2)200,000 USDC\u00a0(x\u2081)100 ETH\u00a0(x\u2082)<\/p>\n The constant k would be: k = (200,0\u2070\u2070\u2070\u00b7\u2078) *\u00a0(1\u2070\u2070\u2070\u00b7\u00b2)<\/p>\n Designed specifically for stable assets, it combines CPMM and\u00a0CSMM:<\/p>\n \u03c7D^n + D = An^n \u03a3x\u1d62 + (D^n)\/n^n<\/p>\n Where:<\/p>\n D: invariant representing total\u00a0depositsn: number of\u00a0coinsA: amplification coefficientx\u1d62: quantity of coin\u00a0i<\/p>\n This model provides:<\/p>\n Low slippage for trades between assets of similar\u00a0valueHigher slippage as prices\u00a0divergeAdjustable amplification factor (A) to balance stability and profitability<\/p>\n For a DAI-USDC pool with A =\u00a0100:<\/p>\n When both assets are at $1, trades have minimal\u00a0slippageIf DAI drops to $0.98, slippage increases to protect the\u00a0pool<\/p>\n A newer innovation that adjusts parameters based on market conditions:<\/p>\n P = f(x, y,\u00a0v)<\/p>\n Where:<\/p>\n P: pricef: price\u00a0functionv: external price feed or other variables<\/p>\n A pool\u00a0might:<\/p>\n Use Chainlink price feeds as a\u00a0baseAdjust liquidity concentration around the current\u00a0priceModify fee tiers based on volatility<\/p>\n Automated market makers represent a paradigm shift in decentralized trading, fundamentally reimagining how markets could function without traditional intermediaries. Though not the most capital-efficient venues, AMMs have democratized market making and allowed for 24\/7 permissionless trading in a wide variety of tokens. The innovative constant product formula of an AMM, though simple in concept, has proven remarkably resilient as a means to maintaining the stability of markets and ensuring consistent liquidity. As DeFi evolves, AMMs are a perfect example of how mathematical principles can be used to create trustless, automated trading systems that everyone can use. While their lack of slippage and impermanent loss will remain their drawbacks, the contributions of these protocols have been fundamental in changing the landscape of decentralized finance and pave the way for future innovations in algorithmic trading mechanisms.<\/p>\n Understanding Automated Market Makers<\/a> was originally published in Coinmonks<\/a> on Medium, where people are continuing the conversation by highlighting and responding to this story.<\/p>","protected":false},"excerpt":{"rendered":" Automated Market Makers (AMMs) are a type of decentralized exchange (DEX) mechanism that enables trustless trading of digital assets without the need for traditional order books. Instead of relying on buyers and sellers to match orders, AMMs use mathematical formulas and liquidity pools to determine asset\u00a0prices. AMM Mechanism The flowchart above outlines the AMM process, […]<\/p>\n","protected":false},"author":0,"featured_media":0,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[2],"tags":[],"class_list":["post-49822","post","type-post","status-publish","format-standard","hentry","category-interesting"],"_links":{"self":[{"href":"https:\/\/mycryptomania.com\/index.php?rest_route=\/wp\/v2\/posts\/49822"}],"collection":[{"href":"https:\/\/mycryptomania.com\/index.php?rest_route=\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/mycryptomania.com\/index.php?rest_route=\/wp\/v2\/types\/post"}],"replies":[{"embeddable":true,"href":"https:\/\/mycryptomania.com\/index.php?rest_route=%2Fwp%2Fv2%2Fcomments&post=49822"}],"version-history":[{"count":0,"href":"https:\/\/mycryptomania.com\/index.php?rest_route=\/wp\/v2\/posts\/49822\/revisions"}],"wp:attachment":[{"href":"https:\/\/mycryptomania.com\/index.php?rest_route=%2Fwp%2Fv2%2Fmedia&parent=49822"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/mycryptomania.com\/index.php?rest_route=%2Fwp%2Fv2%2Fcategories&post=49822"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/mycryptomania.com\/index.php?rest_route=%2Fwp%2Fv2%2Ftags&post=49822"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}1. User Interaction<\/h4>\n
2. Providing Liquidity<\/h4>\n
3. Trading\u00a0Process<\/h4>\n
4. Trade Execution<\/h4>\n
1. Constant Product Market Maker\u00a0(CPMM)<\/h3>\n
Example:<\/h3>\n
2. Constant Sum Market Maker\u00a0(CSMM)<\/h3>\n
Example:<\/h3>\n
3. Constant Mean Market Maker\u00a0(CMMM)<\/h3>\n
Example:<\/h3>\n
4. Hybrid\u00a0Models<\/h3>\n
Curve\u2019s StableSwap<\/h3>\n
Example:<\/h3>\n
5. Dynamic Automated Market Maker (Dynamic-AMM)<\/h3>\n
Example:<\/h3>\n