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AMM, the automated market maker, is one of the most critical technologies for decentralized exchanges (DEX) and has proven to be one of the most influential DeFi innovations in their ability to create and run publicly available on-chain liquidity for a range of different tokens. AMM fundamentally changes the way users trade cryptocurrencies. Unlike traditional order book transactions, both sides of AMM transactions interact with pools of liquid assets on the chain. Liquidity pools allow users to seamlessly switch between tokens on the chain in a completely decentralized and unmanaged manner. Liquidity providers, on the other hand, earn passive income through transaction fees based on their percentage contribution to the asset pool. Uniswap, the DeFi (decentralized finance) project that came out of the blue in 2020, uses a new trading paradigm: AMM (Automated Market Maker) based on blockchain smart contracts. The automatic market maker system (AMM) not only realizes the automation of trading, but also introduces a new trading method and concept for the financial market. It is an innovation from "0 to 1" and is regarded as a paradigm revolution of financial market trading. To understand the changes AMM has brought to financial markets, you need to understand the existing financial market trading system. After nearly two hundred years of development, especially since the information technology revolution of the 1970s, there are two main trading systems in financial markets: bidding system and market maker system. The first is the bidding system, bidding transaction is the market buyers and sellers directly transaction (or entrusted to the agent broker), in the market trading center with two-way price as the benchmark, according to the "price priority", "time priority" and other rules of a system to reach a deal. Because price is driven by buyer's order and seller's order, it is also called order driven system. The bidding system is divided into collection bidding and continuous bidding, in the collection bidding system, the trading is divided into periods, is in a certain specified time, the orders received at different points together for matching transaction; And the continuous bidding system, is in each point of continuous trading, as long as there are two matching orders, the transaction will happen. The second is the market maker transaction, also known as the bilateral quotation transaction, refers to the price quoter as the price maintenance of the market, the price quoter to the market at the same time, the market buyers and sellers according to the quotation with it, but the buyer and seller do not directly conclude a transaction organization mode. This trading method relies on the quotation of market makers to complete the trading, so it is also called quote driven system. The market maker system can be divided into monopoly market maker system and competitive market maker system. In the former, the exchange assigns a securities broker to take charge of the trading of a certain stock, while in the latter, each kind of stock is handled by multiple market makers at the same time. Both the bidding system and the market maker system rely on the Order Book, that is, the Order needs to be attached to the Order Book and the price is used as a signal to trade. In the bidding system, matching is to buy and sell assets at the most favorable price for both sides of the transaction; Similarly, the market maker system requires the market maker to report the buying and selling price in advance, and investors can only place trading orders after seeing the quotation. However, the decentralized exchanges represented by Uniswap have adopted a new trading system that requires neither order books nor counterparties (market makers) to automate the exchange of assets. This magical trading pattern relies on a simple mathematical model: x * y = K, where x and y represent the number of two assets to be traded, and K is a fixed constant. Therefore, these automatic market makers are also known as constant Function Market makers (CFMM). Generally, there are three types of participants in a CFMM: traders, liquidity providers and arbitrageurs. The most important player in the three categories of participants is the liquidity provider (LP), which is responsible for injecting its own assets into Uniswap's smart contracts as a reserve pool of assets to provide liquidity for transactions and thereby generate transaction fee income. The second is arbitrager. they are responsible for correcting the transaction price to ensure that the transaction price is consistent with the market price, but also cause Impermanent Loss, which brings the risk of Loss to the liquidity provider. The automatic market maker system breaks the traditional trading system mode. It does not need order book, quotation from market maker or system matching, but uses the liquidity in the reserve pool to complete the exchange of assets. Most importantly, the trading price of AMM is not determined by the quotation of the market maker or the order of the trader, but by the ratio of the number of two assets in the asset pool, so it is a liquidity-driven trading system. As the financial market trading system becomes increasingly complex, automated market maker mechanism emerges with a simple model like X * Y = K. Since June, decentralized exchanges like CFMM have surged on Ethereum, with average monthly trading volume rising from less than $500 million at the start of the year to $4 billion today. Uniswap, in particular, surpassed many small and medium-sized exchanges in average daily trading volume of $100 million, and reached one-third of the average daily trading volume of Coinbase, the largest CRYPto asset trading platform in the US. This confirms the ancient Chinese philosophical wisdom that ---- avenue is simple. Because of AMM's success on Ethereum in recent months, there has been a lot of discussion about whether AMM can replace the traditional bidding and market maker system. "Your honey is your arsenic," AMM's trading model, with its mathematical simplicity, shines in the market, but it also has its flaws. When competing with traditional trading systems, AMM mainly faces problems such as the inability to independently price, volatile losses and lack of trading depth, making it difficult to replace traditional trading systems. Compared with traditional trading systems, automatic market makers have the advantages of automation, low cost and high efficiency, but they have certain problems in pricing power, volatile losses and trading depth. However, given that the system is only a few years old, it is not appropriate to be too critical of its perfection. In fact, automatic market makers have now become one of the hottest tracks in the blockchain industry. Out of the need for future transformation and strategic development and the prospect of the market, many large companies and start-ups have begun to pay attention to this field and promote the improvement of the system.
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