How Does a ‘Liquidity Pool’ in DeFi Differ from a Centralized Exchange Order Book?
A liquidity pool, used by Automated Market Makers (AMMs) on DEXs, holds two or more tokens and uses a mathematical formula to determine the price. It does not use a traditional order book of bids and asks.
Trades are executed against the pool's assets. The CEX order book uses matching engine logic to pair buyers and sellers.
Liquidity pools introduce 'impermanent loss' but eliminate the need for a direct counterparty.
Glossar
Traditional Order Book
Structure ⎊ A traditional order book is a centralized mechanism used by exchanges to match buy and sell orders for financial assets.
Order Book
Depth ⎊ An order book represents a listing of buy and sell orders for a specific cryptocurrency, option contract, or derivative, displaying price and quantity at various levels.
Centralized Exchange
Custody ⎊ Centralized Exchanges function as custodians for digital assets, managing private key infrastructure and providing a regulated framework for asset holding, a critical component for institutional adoption within cryptocurrency markets.
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).
Automated Market Makers
Architecture ⎊ Automated Market Makers represent a fundamental shift in price discovery, moving away from traditional order book models towards algorithmic execution predicated on mathematical formulas.
Matching Engine Logic
Algorithm ⎊ Matching Engine Logic constitutes the proprietary algorithm that systematically pairs incoming buy and sell orders for crypto assets and derivatives based on a predefined set of rules.