How Automatic Market Makers Revolutionize Digital Trading

The way we trade in financial markets is changing. While traditional brokers have always operated with intermediaries that ensure liquidity, a new model has arrived to shake up this dynamic. Automated Market Makers (AMM) eliminate the need for these intermediaries, allowing anyone to trade digital assets directly and peer-to-peer.

Why are AMMs gaining traction so quickly?

The reason is simple: accessibility and practicality. Unlike centralized brokers, who charge high fees and maintain control over your funds, AMMs operate through simple mathematical protocols. You don't need to trust anyone to make the exchange. The technology itself ensures that the price is fair.

These mechanisms are a fundamental part of decentralized exchange platforms (DEX), creating an ecosystem where ordinary users can provide liquidity and earn from it, without intermediaries.

How does a liquidity pool really work?

Imagine a simple market with just two assets: ETH and DAI. A liquidity pool is like a small market where these two assets are stored. When many people want to swap ETH for DAI, they deposit ETH and receive DAI in exchange.

So what happens then? ETH becomes abundant in the pool, while DAI becomes scarce. Automatically, the price of ETH falls and the price of DAI rises. This is the magic of AMMs: supply and demand itself determines the value, without any human needing to do this calculation.

If there is a large difference between the AMM price and the price on centralized exchanges, traders can profit from this difference – this is what we call arbitrage.

The big difference: AMMs versus order books

Here is the central point: in the traditional order book model, it is the buyers and sellers themselves who state what price they want. The market moves according to them. In the AMM, there is no negotiation between people. An algorithm does everything automatically based on the quantity of each asset in the pool.

To keep prices aligned with reality, AMMs use price oracles – tools that fetch real-time price information from major centralized platforms. Thus, there are no significant discrepancies between what you pay on the AMM and what the asset actually values in the market.

The growth of decentralized finance

AMMs are just one piece of the larger puzzle called DeFi (Decentralized Finance). Their growth reflects users' quest for greater autonomy, lower costs, and the ability to trade without relying on traditional institutions. For those looking to better understand this expanding universe, there are excellent guides on DeFi available in the community.