What Are Automated Market Makers (AMMs) And Why Are They Becoming Popular?

This is the first article in a series of educational articles designed to educate people who may be new to cryptocurrencies about aspects of importance and new developments in the industry.

Recently Uniswap, and its protocol token, UNI, have been trending in the blockchain space, but why? Uniswap is a member of a relatively new type of decentralized exchange; one which is already having a big impact on decentralized finance.

What Are Automated Market Makers?

Automated Market Makers, commonly known as AMMs, are a class of decentralized exchanges where traders trade with a smart contract rather than other people. The price of a token is set by a mathematical formula. Due to this, there are no buy and sell orders, and traders don’t have to find someone to sell their coins to, because the smart contract acts as the maker in the transaction. The most popular AMMs currently are Uniswap, Curve, Kyber, and Balancer.

There are two main types of Automated Market Makers. One type is set up and governed by professional market makers (like Kyber) and the other is completely automated by an algorithm that allows any user in the market to deposit liquidity into the smart contract (like Uniswap, Curve, and Balancer). The second type is more decentralized than the first.

How do Automated Market Makers work?

In Automated Market Makers, a liquidity pool contains two assets in a trading pair. The percentage of each token in that pool determines the theoretical price of an asset. In a Uniswap smart contract, for example, the token price cannot be set or controlled. The price is fully determined by the balance ratio between the two tokens.

The algorithm constantly adjusts the price of each token based on the buying and selling activity in the liquidity pool. So, the price of swapping between one token and another token can vary based on which liquidity pool is chosen and on the volume of the planned transaction. This means that the selection of the right AMM can have an impact on the buying/selling price of the specific token/s.

Why are Automated Market Makers becoming popular?

Cuy Sheffield, Head of Visa’s crypto division, explained why Automated Market Makers are attracting so much attention and becoming popular within the crypto space in a few simple points:

• AMMs are like websites that exist independent of any company or administrator that anyone in the world can quickly use to exchange one asset for another asset.
• AMMs allow anyone to deposit a compatible asset and earn fees when the asset is exchanged.
• Anyone in the world that creates an asset compatible with the particular AMM can easily create a global market for the asset they created to be exchanged with other assets.
• Anyone who wants to buy that asset can instantly access the market for it and acquire it over the internet.
• Anyone can convert between two forms of the same pegged asset. This would be like converting $100 from a PayPal account to $100 in a Cash App account.

If you consider the benefits of individual Automated Market Makers, there are even more reasons why they are becoming popular. For example, Uniswap has zero startup costs and zero operating expenses, which is one reason why Uniswap has such a large share of the DeFi market.

What’s not to like with AMMs? Just develop a crypto asset, deposit it on an Automated Market Maker, and you can earn fees every time the asset is exchanged! It’s no wonder these AMMs are so popular. The fact that you trade with a smart contract so there is no need to search for someone to trade with can also be considered an added bonus.

AMMs, especially Uniswap, have grown in popularity, and have even exceeded the popularity of many Order Book DEXs, but why?

One reason that Uniswap has exceeded many order book DEXs in popularity is that it is simple and easy to use. There is a low surface area for hacks, and there are low integration costs and low gas costs. Uniswap has also not faced as many regulatory challenges. Also, it’s very easy to provide liquidity to Uniswap, which only takes one click. Lastly, it’s extremely easy to create incentivized pools on Uniswap, Balancer, Curve etc. This is the process where someone who created a pool airdrops tokens to liquidity providers, which increases their returns to more than the normal amount.

Uniswap only really started to gain traction in 2019, and now there are many more competitors on the market, which has turned AMMs into an exchange class of their own.

Automated Market Makers and the Future of DeFi

AMMs are a great option for debuting new tokens and provide a lot of advantages, which is one of the reasons that CryptoLocally decided to hold the GIV Bonding Curve Distribution Event on Uniswap and Balancer. The increase in popularity of AMMs has helped to further the rise of DeFi, and as DeFi technology becomes more well known, it will be able to have an even greater positive impact.