In the world of bitcoin, there is a term called an automated market maker. It is a protocol that allows direct exchanges to happen. Before introducing AMM, you needed a broker or middle man to oversee you buying and selling of any BTC. Automated market makers came to remove a centralized market exchange technique. Instead, it made it so that you could just buy or sell directly. To understand what an automated market maker is, you first need to know what market makers are. Here are what you need to know about a computerized market maker.
What is a Market Maker?
It is a centralized system that connects buyers to willing sellers. It acts as the middleman whose work is to notice a buyer and then search for a seller who is willing to sell at the same amount the buyer is offering. Take a case scenario. Customer x wants to buy 5 BTC. A market maker will quickly look for a seller willing to sell 5BTC.
The seller must be willing to accept the amount of cash that customer x is offering. A market maker must work very fast, and the process seems automatic. If there is no willing seller for buyer x, then the liquidity of that bitcoin is proclaimed low.
An Automated Market Maker
An automated market like solana blockchain is a direct exchange. The most significant difference between an AMM and a typical market maker is that the computerized market maker eliminates the middleman. Thus, it is a direct exchange commonly known as DEX.
DEXs eradicate order matching with protocols that are called AMMs. Instead, these protocols use a computer program called smart contracts. This program works on its own to develop a price for a digital asset, thus creating liquidity.
Liquidity in terms of digital assets is like the availability of the asset for selling. In traditional exchanges, only high-selling firms can become liquidity providers. However, any individual who fulfills the requirements can become a liquidity provider with automated market makers.
How does an Automated Market Maker Work?
To ensure that liquidity pools are balanced at all times, most companies that deal with AMM use a mathematical equation. “x*y=k.” in this case, x represents the value of one asset. At the same time, y is the value of the other asset. K is a constant.
Take another case scenario with two digital assets in a liquidity pool: c and d. A trader purchases c and adds d to the pool. As a result, c decreases, whereas d increases. Therefore, the price of c must increase, and d will reduce. It will happen like this to fulfill the equation, x*y=k, which should always work.
The opposite, where d decreases and c increases in the liquidity pool, will also work similarly, and doing this helps to create balance at all times.
Bottom Line
Automated market makers like solana blockchain are slowly replacing traditional trading methods. Seeing the elimination of the need for a middleman, most traders prefer using them. They work to ensure that there is balance in the market of digital assets.
