📝 Definition:
An Automated Market Maker (AMM) is a type of decentralized exchange (DEX) that uses smart contracts to automatically set the price of cryptocurrencies and make trades happen.
Instead of traditional buy and sell orders, AMMs use pools of crypto provided by users where trades are done directly.
🔑 Key Features:
- Decentralized Trading: An Automated Market Maker (AMM) doesn't need a central authority or list of people trying to buy and sell.
- Crypto Pools: It uses pools of cryptocurrency provided by users to make trading possible.
- Automated Pricing: Prices are determined by algorithms and the amount of crypto in the pool.
- Rewards for Users: Users who provide crypto to the pools earn fees from trades.
⚙️ How It Works:
- Create Crypto Pool: Users deposit pairs of cryptocurrencies into a pool (e.g., ETH and USDT).
- Automated Pricing: An algorithm sets the price based on how much of the two cryptocurrencies are in the pool.
- Trade Execution: Traders exchange one cryptocurrency for another directly from the pool.
- Earning Fees: Users who put crypto into the pools earn a percentage of the transaction fees as a reward.
💡 Applications:
- Decentralized Exchanges: Platforms like Uniswap, SushiSwap, and Balancer use AMMs to enable trading without middlemen.
- Yield Farming: Users earn more rewards by putting crypto into the pools and doing yield farming.
- Token Swaps: AMMs allow quick and easy exchanging between different tokens.
- Price Discovery: Helps determine the market price of new or less traded tokens by letting the algorithm fix the price depending on the supply and demand.
🔍 Example:
Imagine you want to trade your Ethereum (ETH) for USDT.
On an AMM platform like Uniswap, you put your ETH into a pool of crypto, and the algorithm calculates how much USDT you will get based on how much of each crypto is in the pool.
The trade happens instantly without needing someone else to be there to buy or sell.