On AMM platforms, instead of trading between buyers and sellers, users trade against a pool of tokens - a liquidity pool. The more assets in a pool and the more liquidity the pool has, the easier trading becomes on decentralized exchanges. AMMs fix this problem of limited liquidity by creating liquidity pools and offering liquidity providers the incentive to supply these pools with assets. As a new technology with a complicated interface, the number of buyers and sellers was small, which meant it was difficult to find enough people willing to trade on a regular basis.
Before AMMs came into play, liquidity was a challenge for decentralized exchanges (DEXs) on Ethereum. Liquidity refers to how easily one asset can be converted into another asset, often a fiat currency, without affecting its market price. This new method of exchanging assets embodies the ideals of Ethereum, crypto, and blockchain technology in general: no one entity controls the system, and anyone can build new solutions and participate. This new technology is decentralized, always available for trading, and does not rely on the traditional interaction between buyers and sellers. However, AMMs have a different approach to trading assets.ĪMMs are a financial tool unique to Ethereum and decentralized finance (DeFi). Stocks, gold, real estate, and most other assets rely on this traditional market structure for trading. When other users find a listed price to be acceptable, they execute a trade and that price becomes the asset’s market price. On a traditional exchange platform, buyers and sellers offer up different prices for an asset.
Automated market makers (AMMs) allow digital assets to be traded without permission and automatically by using liquidity pools instead of a traditional market of buyers and sellers.
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