How To Use Automated Market Makers (AMMs)

Market Meditations | January 7, 2022

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One of the keystones of the decentralised finance movement is the removal of intermediaries and custodians from the entire monetary system.

One of the most important parts of the DeFi machine is the Automated Market Maker (AMM).

Decentralised Exchanges (DEX) achieve this goal by employing automated market makers to incentivise users to provide liquidity to pools in an exchange for a rewards

These rewards are produced by fees other users pay to patronize services offered by the AMM, like exchanging one token for another.

While centralised exchanges oversee the operations of traders, acting as the middleman between two parties desiring to make an exchange, AMMs utilise an approach employing the execution of smart contracts instead. This automates the process without the need to trust a centralised entity.

✅ Tip! A liquidity pool (LP) consists of two different tokens. These assets are provided by users in designated pairs, USDT and ETH for example. When a user wants to exchange USDT for ETH, the pool facilitates the transaction. A fee is charged to the person making the swap. A portion of that fee is then used to reward providers of liquidity in that pool.

AMMs and the DEXs they serve are some of the most popular tools being used in DeFi.

PancakeSwap is a popular decentralised exchange reliant on the function of its AMM. Its position as the leading AMM on the Binance Smart Chain contributes to its status as one of the most popular DEXs.

  • PancakeSwap facilitates swapping and trading without the need for including a centralised exchange.
  • Yield farming/liquidity mining is a core attraction of users to the platform. Providing liquidity earns LP tokens, which carry with them rewards in the form of trading fees.
  • LP tokens can also be locked in a smart contract to earn $CAKE – PancakeSwap’s native token.
  • PancakeSwap, like many other DEXs, affords the opportunity to participate in initial offerings for different project and token launches.

Understanding automated market makers and how they work should be an essential part of due diligence.

Many models exist, with a few claiming responsibility for the vast majority of DEXs out there. It’s always important to know how the mechanics of platforms function to accurately assess the long-term growth and sustainability of an ecosystem.