How Do Liquidity Pools on Decentralized Exchanges (DEXs) Differ from Traditional Order Books?
Liquidity pools on decentralized exchanges (DEXs) differ from traditional order books in that they use an automated market maker (AMM) system instead of a central limit order book. In a traditional order book, buyers and sellers place orders at specific prices, and the exchange matches them.
In a liquidity pool, users deposit pairs of assets into a smart contract, which then provides liquidity for other users to trade against. The price of the assets in the pool is determined by a mathematical formula, rather than by the actions of individual buyers and sellers.
This allows for continuous liquidity, even for assets with low trading volume.
Glossar
Automated Market Maker
Architecture ⎊ Automated Market Makers (AMMs) represent a paradigm shift in decentralized exchange, employing mathematical formulas to determine asset prices and facilitate trading without traditional order books.
Traditional Order Books
Mechanism ⎊ Traditional order books represent a deterministic system for price discovery and trade execution, fundamentally relying on the aggregation of discrete buy and sell orders submitted by market participants.
Decentralized Exchanges
Access ⎊ These platforms offer permissionless entry to cryptocurrency and tokenized asset markets, democratizing capital deployment into novel financial structures.
Liquidity Pools
Mechanism ⎊ Liquidity pools represent a fundamental shift in market microstructure, functioning as decentralized exchange (DEX) components that facilitate trading via automated market makers (AMMs).