AMM: Automated Market Maker

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Asset exchanges have historically relied on the traditional order-book-style matching of submitted bids and asks to execute trades. In 2017, Bancor exchange removed order books entirely — and instead introduced a network of on-chain liquidity pools to pair pools of tokens with one another. Users can trade against these pooled token pairs, with prices set algorithmically based on both the size of the user’s trade and the depth of the corresponding token pools.

This novel approach to market making proved to be a paradigm shift within the decentralized exchange (DEX) space. Traders now have guaranteed access to on-chain liquidity with transparent, upfront pricing, doing away with the need for a counterparty. Token owners can also turn existing holdings into productive assets through liquidity provision to these DEX pools, earning returns from protocol swap fees imposed on trades that get routed through the platform.

This has turned pooled market-maker liquidity into a new asset class (“liquidity positions”), allowing for broader, more competitive involvement in market making.

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