What Are the Primary Mechanisms through Which Automated Market Makers (AMMs) Facilitate Token Swaps?
AMMs facilitate token swaps using liquidity pools and a deterministic pricing algorithm. Instead of a traditional order book, users trade against a pool of tokens supplied by liquidity providers.
The price is determined by a formula, most commonly the constant product formula (x y=k), where 'x' and 'y' are the quantities of the two tokens in the pool. Each trade alters the ratio of tokens in the pool, causing the price to adjust automatically for the next trade, ensuring continuous liquidity.
Glossar
Constant Sum Formula
Mechanism ⎊ The Constant Sum Formula, sometimes employed in specialized stablecoin AMMs, dictates that the sum of the reserves ($x + y = k$) remains fixed, implying a constant marginal price of one-to-one regardless of the trade size.
Automated Market Makers (AMMs)
Mechanism ⎊ Automated Market Makers (AMMs) represent a fundamental shift in market microstructure, replacing traditional order books with algorithmic liquidity provision.
Constant Product
Invariant ⎊ The core principle dictates that the product of the quantities of the two assets in a liquidity pool remains constant, represented mathematically as $x cdot y = k$, where $x$ and $y$ are the reserves of the two tokens.
Constant Product Formula
Formula ⎊ The Constant Product Formula, a cornerstone of Automated Market Makers (AMMs) like Uniswap, dictates the relationship between the reserves of two tokens within a liquidity pool.
Liquidity Provisioning
Action ⎊ Liquidity Provisioning is the act of depositing capital into a decentralized exchange pool or providing margin to a lending market to facilitate trading and borrowing activities within a DeFi protocol.
Deterministic Pricing
Foundation ⎊ Deterministic pricing within cryptocurrency derivatives signifies a valuation methodology predicated on explicitly defined, observable parameters, eschewing probabilistic models reliant on implied volatility.