Automated Market Maker (AMM) [Updated]

An automated market maker (AMM) is a system that provides liquidity to the exchange it operates in through automated trading.

An automated market maker (AMM) is a type of decentralized exchange (DEX) protocol that allows users to buy and sell digital assets without the need for a third-party intermediary. AMMs automate the process of pricing and matching orders on the exchange, typically using an algorithm to determine the prices at which buyers and sellers can trade assets. This means that users can purchase and sell crypto assets in a trustless, peer-to-peer fashion without needing to rely on a custodian or other third party.

AMMs are popular for their simplicity, ease of use and low fees. Traders can quickly open and close positions without worrying about order types, order matching or other complexities that come with traditional exchanges. Additionally, AMM exchanges are often faster and more secure than their centralized counterparts, as they are powered by smart contracts and protected by the underlying blockchain network.

AMM systems took off after Shearson Lehman Brothers and ATD first implemented them in the early 1990s. Before their invention, order books were created by humans who manually initiated trades meant to enhance the liquidity of the market. This approach was the reason for some slippage and latency in price discovery on the markets. Furthermore, market makers were also accused of market manipulation. AMMs solved all the issues caused by human market makers.

The main difference between an AMM and an order book model is that an AMM is a liquidity pool that automatically sets prices based on the amount of liquidity within the pool. An order book model facilitates price discovery through buyers and sellers setting their own prices.