In order to trade on a traditional exchange, you need to have a buy or sell order that’s listed in the order book. This helps traders find each other and trade quickly and efficiently, allowing them to maximize their profits by avoiding inventory risk and execution costs.
Market makers (MMs) are a type of liquidity provider who guarantee that they will be willing to buy or sell a specific quantity of an asset at a specific price. They make their money by taking the bid-ask spread, a time-tested system that’s been used for centuries. In addition, market makers may also offer other services such as arbitrage across a number of different exchanges where a token can be traded.
AMMs are some of the earliest applications of decentralized finance and remain among the most prominent DeFi products today. AMM-based exchanges are processing billions of dollars worth of on-chain transactions every day, and they’re a critical part of delivering DeFi to the masses.
An Automated Defi Market Maker is a type of cryptocurrency exchange that allows users to trade trustlessly without using an order book, using algorithms to price assets in liquidity pools. Some AMMs use simple formulas like Uniswap, while others such as Balancer and Curve Finance offer more complicated ones.
Despite their popularity in the crypto space, AMMs aren’t perfect, and they’re not a complete solution to all of the problems associated with liquidity provision. Fortunately, new alternatives have emerged that tackle these issues more effectively.
Liquidity mining and yield farming are two important ways that DeFi enthusiasts can earn passive income by providing liquidity to DEXes. These strategies can be used to both diversify your portfolio and maximize your returns from investing in the volatile world of DeFi.
In the context of automated market makers, liquidity mining involves providing liquidity to AMM-based exchanges by transferring your unused or idle assets into a pool that can be traded in order to earn trading fees. In return, you receive a reward in the form of a corresponding liquidity provider token that can be traded easily on AMM-based exchanges.
Yield farming is similar to liquidity mining but differs in a few key ways. It involves generating liquidity for an asset by trading it at high prices in a market where it’s undervalued or hasn’t yet reached its maximum value. It’s a great way to earn passive income by utilizing your unused assets, and it can be very profitable for those who have the capital to commit.
AMMs are a key part of democratizing liquidity provision in the DeFi space and they’ve greatly improved the capabilities of existing DEXs. However, they still have a ways to go before they align more closely with the ethos of DeFi.
With so much innovation happening in the DeFi space, it’s crucial that we keep an eye on what is possible and what isn’t. In order to do that, we’ll take a look at some of the main issues surrounding AMMs, and how alternative solutions may be able to resolve them.