You can think of automated markets as a robot that is always ready to offer you a price between two assets. Automated markets allow for peer-to-peer trading without centralized governance through liquidity pools instead of the order book. Rather than purchasing cryptocurrencies from a centralized exchange, AMMs use funds from liquidity providers (users) to facilitate token exchanges. This is an application of decentralized finance.
How it works ⚙️
Rather than entrusting the custody of your assets to a centralized exchange such as Binance or Coinbase, and having to take a cut of every transaction you make, a decentralized exchange platform, also known as (DEX) for decentralized exchange, allows for the live exchange of your cryptos directly from your personal wallet, as such the use of a wallet such as MetaMask is required.
A typical centralized cryptocurrency exchange uses an order book and an order matching system to match buyers and sellers on a corresponding price. The order book is a dynamic, real-time electronic ledger that stores and displays all orders to buy or sell a crypto-currency at different prices.
In the context of decentralized systems, automatic liquidators intervene to define prices, which is the name given to the virtual guardians of automated markets. They represent the smart contracts that are created in so-called token liquidity pools. They are automatically traded by an algorithm rather than an order book. You trade with the machine, there is no third party in the traditional sense of the word or a buyer match with a seller, the trades are from users to the automatic contracts.
The AMM determines the price of the tokens based on pre-established mathematical formulas. The capital used to fund these liquidity pools is financed by user crowdfunding. In exchange for contributing liquidity, users receive a percentage of the fees earned by the protocol.
How are the prices determined? 📊
Prices are determined by the quantity of each token in the pool. The smart contract maintains a constant using the following function: x*y=k. In this case, x = token0, y = token1, k = constant. At each exchange, a certain amount of one token is removed from the pool for an amount of the other token. To maintain k, the balances held by the smart contract are adjusted during the execution of the trade, thus changing the price.
x*y=k. x = token0, y = token1, k = constant
Algorithmic formula of Uniswap and its clones.
This means that the total liquidity of the pool remains constant. Other WMAs use different formulas depending on the use case they are targeting. What all these automatic markets have in common is that the price of the assets is determined algorithmically.
The most well-known automatic markets by network 🥇
These decentralized markets are mostly not compatible with several blockchains simultaneously. So there is an automatic exchange for each blockchain offering tokens. Let's take a look at the three biggest automatic services in decentralized finance.
Uniswap 🦄
The reference on the Ethereum blockchain. Uniswap is a very big player in DeFi (decentralized finance) with 4 billion dollars of swap each week. Uniswap is performing well and offers today an incalculable number of tokens on ERC-20. The only downside for the moment is the abnormal network fees. While waiting for Ethereum 2.0, Uniswap remains heavy for small investments with fees around $10 per transaction. This represents a huge loss of earnings, this part being nibbled by the miners for the proper functioning of the network.
PancakeSwap 🥞
The flagship tool of the Binance Smart Chain, the automated PancakeSwap service specializes in BEP-20 quality token swaps. This is the Binance Smart Chain. The big strength of the BSC is its very low fees compared to the Ethereum network. Additional services are also available on PancakeSwap like farming and syrops pool. A more lucrative way to monetize your savings compared to the simple liquidity pools offered by Uniswap.
QuickSwap 🐉
The Polygon blockchain swap service. Newly arrived on the market, the Polygon network is a sidechain of Ethereum, that is to say a parallel blockchain also called second layer (layer-2) on which assets can be transferred from one network to another. This has the effect of increasing the scalability of the Ethereum network, while offering a very fast blockchain with ultra low costs. You can therefore use QuickSwap to send your compatible funds on the Polygon network in order to avoid paying indecent fees for your transfers or take advantage of liquidity mining services.
There are many swap services, I have voluntarily cited recognized services is validated by the various communities of users. Without forgetting SuchiSwap, 1inch or others equally efficient. With the increase in the number of blockchain in circulation, the increase in the number of sidechain and services offering interoperability between networks, new swapping services should appear very soon.
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