What are Automated Market Makers Like Uniswap

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Automated Market Makers (AMM) are one of the most popular DeFi applications today. An AMM is a decentralized asset trading pool that enables market participants to buy or sell cryptocurrencies. AMMs are non-custodial, meaning you never give up control of your funds like on a centralized exchange, and they’re permissionless in nature, meaning all you need is an Ethereum wallet to trade or provide liquidity to earn fees while others trade with your tokens. 

The golden child of DeFi, Uniswap, has even eclipsed popular centralized exchanges in trading volume like Coinbase Pro and Kraken.

Uniswap was one of the first to pioneer the concept of an Automated Market Maker, launching in October 2018. AMMs rely on pools of token liquidity, where each ERC20 token is paired with a pool of ETH, instead of an order book. The mechanism, combined with a bonding curve which calculates the exchange rate of a token swap, allows users to exchange any two tokens, without the need of a centralized party.

AMMs flipped the idea of a decentralized exchange on its head in 3 ways.

First, an AMM makes it easy and user-friendly for anyone to provide liquidity for new ERC20 tokens paired with ETH. The days of waiting for a CEX to list a token are gone! As soon as teams launch a token, they can deposit the token into a new pool in Uniswap and traders can instantly begin buying and selling the token. This is what we mean when we say Uniswap and AMMs are special due to their permissionless nature.

Second, Uniswap presented a shift from a CEX collecting 100% of trading fees to a community-owned DEX, where those providing liquidity earn all the fees! If there were ever a co-op bookstore of crypto trading, Uniswap is it. Uniswap empowered its users with the ability to provide liquidity for any token and start trading tokens instantly–those who provide liquidity earn a portion of fees paid by those trading. In Uniswap, it’s been a simple flat 0.3% fee and so if I hold 1% of the liquidity in a pool like ETH – DAI, then I earn 1% of all fees paid by traders. Historically, the most volatile days in crypto, especially market crashes, have only benefitted CEXs collecting record revenue on record trading volume. With Uniswap, suddenly the Uniswap community that powers all liquidity provisions can earn record fees on record trading volume days. This is part of the reason behind the cult-like following Uniswap has attracted.

Lastly, Uniswap and AMMs like it represent yet another way DeFi has provided a parallel to legacy finance where you can maintain 100% control of your funds. When you trade on a CEX, there’s always risk in depositing because you have to trust a CEX to not lose your funds. With AMMs like Uniswap, you trust no one but the code. In the case of Uniswap, it’s battle-tested code with billions of trade volume over the years, and countless audits. There’s still risk to using Uniswap, but you escape the need for KYC or any sort of sign-up. It’s the cypherpunk dream realized in the form of code that can outlive the team who created it.

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