The Uniswap team has already built the protocol fee into the smart contract parameters. This has yet to be activated, as it is currently pending the development of a protocol governance system. Trades that are routed through more than one pool are accompanied by a 0.6% fee in order to complete the trade since each pool in the protocol charges its own fee. The Kyber Katalyst upgrade allows dapp developers to add a custom spread to the tokens in the pool.

Over the past few years, many innovative financial tools have graced the decentralized crypto space. Unabbreviated as the, AMMs ensure trustless transactions and trades across decentralized exchanges (DEXs), focusing on democratizing finance. The makers remove the need for intermediaries and traditional market-making mechanisms, such as order-matching systems and other custodial methods. For traders, AMMs allow for an instant trade experience bought at market price; for liquidity providers, market participants can earn trading fees from each trade. The constant, represented by “k” means there is a constant balance of assets that determines the price of tokens in a liquidity pool. For example, if an AMM has ether (ETH) and bitcoin (BTC), two volatile assets, every time ETH is bought, the price of ETH goes up as there is less ETH in the pool than before the purchase.

A Brief Introduction to Automated Market Makers (AMM)

On many decentralized exchanges, the Automated Maker Model is preferred for trading cryptocurrencies. Several popular cross-chain market makers, like the Synapse Protocol, THORChain, Ren Protocol, and more, allow users to swap tokens across chains. These are specialized market makers meant to simplify NFT trades. These AMMs are meant to infuse liquidity into the otherwise illiquid NFT space. The operating principle of these AMMs relies on a special formula where the price of an asset is represented by the amount of both the assets in the pool and not just one asset. One such example is Curve Finance, a platform used to trade stablecoins.

  • The order book exchange definitely presents a proven approach for global finance, which involves multiple market makers alongside many investors.
  • To participate in yield farming, users just need to add an appropriate balance of assets into a liquidity pool.
  • However, the traditional market maker process is quite time-consuming when smart contracts are involved.
  • In the case of Uniswap v2, you can find a transaction fee worth 0.3%, which is transferred directly to liquidity providers.

The opinions and views expressed in any Cryptopedia article are solely those of the author(s) and do not reflect the opinions of Gemini or its management. A qualified professional should be consulted prior to making financial decisions. Diego, a blockchain enthusiast, who is willing to share all his learning and knowledge about blockchain technology with the public. He is also known as an «Innovation evangelist for blockchain technologies» due to his expertise in the industry.

Concept, research, design & implementation by DeFi Wonderland

Users supply liquidity pools with tokens and the price of the tokens in the pool is determined by a mathematical formula. By tweaking the formula, liquidity pools can be optimized for different purposes. As you can notice, different types of Automated Market Makers on decentralized exchanges or DEXs have changed the ways of determining the price of crypto assets for trading. However, AMMs also comes with some risks such as vulnerability of smart contracts, impermanent loss, and safety procedures.

automated market maker

In event of a relatively small range of the price ratio between a token pair, the impermanent loss becomes negligible. The most striking highlight about or AMMs directly refers to the fact that buyers and sellers don’t have to wait for counterparties to sell or buy crypto on DEXs. However, some agent has to take the responsibility of creating the market. You still need liquidity in the smart contract, which can enable trade on AMMs without counterparties.

What Is an Automated Market Maker (AMM)?

This concerns when the price of assets supplied by the liquidity providers moves in another direction, pushing them towards liquidation risks. Despite being a source of impermanent loss, AMMs also offer solutions to the same. These can be in the form of probabilistic AMMs with specialized mathematical algorithms in play. This phenomenon is called “impermanent” loss because as soon as the tokens’ prices within the AMM converge back to their original values, the losses disappear. However, the LPs still get to keep their earned fees and token rewards as profit.

This article digs deep into automated market makers, how they work, liquidity pools and liquidity providers, types of automatic market makers, and the risk of impermanent loss. On a final note, it is clearly evident that Automated Market Makers have a crucial role in defining the foundation for the future of crypto trades. AMMs are protocols that can enable investors to purchase or sell crypto on decentralized exchanges without counterparties for the trade. Therefore, automated market maker protocols could introduce massive levels of flexibility in the domain of crypto trading. Interestingly, AMM-based exchanges present some notable differences from centralized exchanges. At the same time, we have also witnessed the growth of decentralized exchanges.

Future Of Automated Market Makers

Aside from earning a portion of the protocol’s fees, the governance tokens represent an additional income source for liquidity providers. The tokens are called governance tokens because they often confer certain rights, such as voting rights on protocol changes or rights to a portion of the protocol’s profits. When the user provides liquidity to the pool by depositing their tokens into it, they are automatically converted into several types of tokens, based on the balance needs of the pool.

automated market maker

Then we have Curve Finance, where the pools primarily deal in stablecoins — which are intended to hold steady values. These AMMs, at their core, are meant to facilitate lending and borrowing. Users supply or deposit assets into pools, earning interest in the process. On the other hand, borrowers can loan out assets at pre-determined interest rates.


An AMM works like a decentralized exchange powered by smart contracts and a mathematical formula used to determine the assets’ price. Simply, an AMM facilitates automated trading by creating or, rather, making a market with high token-based liquidity. As a technology, an automated market maker involves smart contracts, ensuring that trade facilitation is handled by code and not by humans. Simply put, it orchestrates a harmony in the DeFi space, where price discovery, trades, transactions, token swaps, and other components move in sync with each other. Powered by blockchain technology and suitable for the financial crypto markets, an AMM has several components running the behind the curtains. Locking assets in a pool is mainly incentivized by the opportunity of yield farming through the transaction fees accumulated by the pool.

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