What is an AMM?
#АММ (automated market makers) are algorithmic protocols used on decentralized exchanges (#DEX ) for the automatic pricing of assets and conducting trades between users. Unlike traditional market makers who provide liquidity manually, AMMs allow users to trade tokens directly with a liquidity pool managed by an algorithm. The primary goal of AMMs is to provide instant liquidity for trades, avoiding the need for intermediaries and maintaining a decentralized trading structure.

AMMs offer several important advantages for participants in the cryptocurrency market. Firstly, they help eliminate the problem of low liquidity that is characteristic of less popular assets. Secondly, they provide the ability for seamless trading without the need to resort to centralized exchanges, which is particularly important for decentralized finance (#DeFi ). Finally, AMMs allow users to earn income from providing liquidity, making them active participants in the DeFi ecosystem.

The history of AMMs
The emergence of automated market makers is linked to the development of decentralized finance and the need for new ways to manage liquidity in cryptocurrency markets. The first AMM protocol, Bancor, was launched in 2017 and became a pioneer in using liquidity pools to facilitate decentralized trading operations. Bancor offered a new liquidity model based on the use of smart contracts, which reduced dependence on centralized exchanges and market makers.

Uniswap, launched in 2018, introduced a simpler and more efficient AMM model with a constant product (Constant Product Market Maker). This model quickly gained popularity due to its openness and accessibility: Uniswap allowed anyone to create their own liquidity pool and start trading any tokens on the Ethereum platform. This marked an important milestone in the development of DeFi and contributed to the widespread adoption of automated market makers. In subsequent years, other successful AMMs emerged, such as Curve, which specializes in stable assets, Balancer, which supports multi-component pools, and SushiSwap, which expanded Uniswap's functionality.

How does an automated market maker work?
An automated market maker (AMM) uses mathematical formulas and algorithms to determine prices and manage liquidity in trading pairs. Unlike traditional centralized exchanges, where prices are set by buyers and sellers through an order book, AMMs use liquidity pools where the price is automatically determined based on the ratio of tokens in the pool.

Each liquidity pool contains two or more tokens, and its operation is based on a mathematical formula that regulates their value. Users, known as liquidity providers (LP), contribute their tokens to the pool and receive liquidity tokens in return, representing their share in the pool. For each trade in the liquidity pool, LPs receive a fee, which incentivizes them to provide their assets for trading.

The AMM algorithm automatically adjusts the price based on the amount of tokens in the pool, which helps avoid manipulation and creates a transparent and fair pricing system. This makes AMMs very attractive for various financial applications and users looking for secure and decentralized trading methods.

Why are liquidity pools necessary for AMMs?
Liquidity pools are a key component of AMM operations and enable the automatic execution of trades on decentralized exchanges. They are created from the funds of liquidity providers who contribute tokens in exchange for commission rewards. A liquidity pool allows automated market makers to maintain a constant trading volume and ensure instant execution of trades without the need for traditional asset listings or the use of an order book.

What is a liquidity pool and how does it work?
A liquidity pool is a smart contract containing a certain amount of tokens of two or more types. When users add their tokens to the pool, they receive tokens #LP , which can be used to receive their share of the fees from each transaction. In case of a price change of the tokens, the AMM algorithm automatically adjusts the value, ensuring a balance between the assets in the pool.

Liquidity pools solve several important problems inherent to centralized exchanges. Firstly, they eliminate the need for market makers who manage orders and balances. Secondly, they help avoid the low liquidity problem for less popular assets since users provide liquidity themselves rather than waiting for counter-orders.

Additionally, liquidity pools open up new opportunities for passive income: users can earn fees for every transaction that passes through the pool, making them active participants in the DeFi financial ecosystem. This approach allows every user to become part of the system, participate in governance, and even influence the platform's development.

What are impermanent losses?
Impermanent losses are the difference between holding tokens in a liquidity pool and storing them outside the pool. These losses occur when the price of tokens in the pool changes relative to their price in the external market. If the price of one of the tokens changes, the number of tokens in the pool will automatically adjust to maintain balance according to the AMM algorithm.

If a liquidity provider decides to withdraw their funds at a time when the token prices significantly differ from their original level, they may receive less than if they had simply held those tokens. Impermanent losses become permanent if the user withdraws their tokens at the moment of their maximum price discrepancy.

To minimize impermanent losses, hedging and risk coverage strategies have been developed, such as using stablecoins in pools or dynamic asset management strategies. Some protocols, such as Balancer or Curve, offer additional mechanisms to minimize impermanent losses, allowing liquidity providers to maintain more stable income.

How pricing of liquidity pools occurs
Pricing in AMM is based on a mathematical formula that regulates the balance of tokens in the liquidity pool. In most AMM models, the formula x * y = k is used, where x and y are the amounts of tokens in the pool, and k is a constant that remains unchanged. This formula ensures that the value of one token relative to another changes automatically with each transaction, maintaining balance in the pool.

The AMM pricing mechanism allows avoiding the need for traditional asset listings and dependence on centralized exchanges. Instead, users can instantly swap tokens based on the asset balance in the pool. This makes AMMs particularly effective for trading on decentralized exchanges, where speed and liquidity availability are crucial.

Additional pricing models, such as constant sum or average models, are also used to improve the efficiency of liquidity pools and reduce risks associated with market volatility. These models allow AMMs to adapt to different market conditions and provide more flexible asset management.

What are the models of automated market makers (AMM)?
There are several models of automated market makers, each using its own formula for pricing and managing liquidity. Let's consider the most popular models:

Constant Sum Market Maker (CSMM)
CSMM (Constant Sum Market Maker) uses a formula where the sum of all tokens in the pool remains constant. This type of AMM does not allow changing the number of tokens in the pool, making it less flexible in conditions of market volatility. However, it can be useful for creating liquidity in trading between assets with very similar values, such as stablecoins.

The CSMM model is applied on platforms where price stability and minimization of speculative risks are important. For example, it can be used for exchanges trading parity assets, where small price fluctuations can be easily smoothed out due to the constant sum approach. This allows maintaining liquidity in stable pairs without significant losses for liquidity providers.

Constant Mean Market Maker (CMMM)
CMMM (Constant Mean Market Maker) uses complex mathematical formulas to maintain the average value of tokens in the pool at a constant level. This model allows for a more accurate reflection of market price changes and reduces impermanent losses. It is well suited for creating liquidity pools that support a variety of assets with different volatility.

The application of CMMM models is particularly relevant for multi-asset pools, where it is important to maintain balance between several tokens. Protocols such as Balancer use this approach to create more flexible and adaptive pools, where users can determine their own token ratios and manage risks more effectively.

Constant Product Market Maker (CPMM)
CPMM (Constant Product Market Maker) is the most popular AMM model used by protocols such as Uniswap and SushiSwap. It is based on maintaining a constant product of the number of tokens in the pool, making it flexible and efficient for working in high-volatility conditions. CPMM allows using the simple formula x * y = k, ensuring transparency and predictability of prices.

CPMM is ideal for users who need instant liquidity and are willing to take on risks associated with price volatility. It supports a variety of trading strategies and allows users to exchange tokens quickly and with minimal costs.

This article is for informational purposes only and does not constitute investment advice. Thank you for subscriptions, likes, comments!
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