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I Z U N
Automated Market Makers (AMMs) represent a transformative shift from traditional market makers by using algorithmic rules, rather than human intermediaries, to facilitate asset trading. Popularized by decentralized finance (DeFi) platforms like Uniswap and SushiSwap, AMMs enable seamless, trustless trading on the blockchain, offering liquidity through pools funded by users rather than financial institutions.
Traditional market makers operate on order books, where buyers and sellers post prices, and market makers facilitate trades to maintain liquidity and narrow spreads. AMMs, however, use algorithms—typically the constant product formula x⋅y=k—to manage prices based on the liquidity pool’s asset ratios. This algorithmic approach eliminates the need for counterparties or centralized control, allowing trades to execute immediately at prices determined by the pool’s composition.
One major benefit of AMMs is accessibility. Anyone can become a liquidity provider (LP) by depositing assets into a liquidity pool, earning fees from trades proportional to their share of the pool. This democratizes liquidity provision, opening market access and enabling passive income for retail investors. AMMs also operate 24/7, offering continuous trading without reliance on centralized intermediaries, thus enhancing transparency and decentralization.
A unique risk in AMMs is impermanent loss, which occurs when the price ratio between two pooled assets changes significantly. This loss is “impermanent” because it only materializes when LPs withdraw their funds, but it can erode gains, especially during volatile price swings. For instance, if the value of one asset in the pool appreciates or depreciates dramatically, LPs may end up with a less favorable asset ratio, potentially losing out compared to simply holding the assets separately.
