What is an Automated Market Maker (AMM)?
Automated Market Maker (AMM) is a type of Decentralized Exchange (DEX) that uses a mathematical formula and liquidity pools for financial services. Uniswap, SushiSwap, PancakeSwap, and Bancor are a few examples of AMM-based DEXs.
The AMM’s mathematical formula determines the swap pricing and balances the liquidity pool.
While more traditional crypto exchanges like Coinbase and Binance use order book methods, AMMs are based on smart contracts; thus, they only trade cryptocurrencies that support smart contracts.
So AMMs support Ethereum (ETH) and ERC-20 tokens like USD Tether (USDT) and Wrapped Bitcoin (WBTC). But coins like Bitcoin (BTC), Litecoin (LTC), and Dogecoin (DOGE) are not supported.
DeFi and AMM
AMM is the most impactful innovation of Decentralized Finance (DeFi). It has fundamentally changed how cryptocurrencies are swapped.
On AMM-based DEXs, users can swap tokens like USDT<>USDC, WBTC<>ETH, and DAI<>MKR in a completely decentralized and non-custodial way. Whereas exchanges like Coinbase and Binance are centralized, custodial, and use the order book process for swapping.
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