Before, we talked about how you can exchange one currency for another through someone else who wants to make the opposite trade. This can be done in a person-to-person (P2P) way, but here’s the hitch: the people doing the trading decide on the prices, and it might not match the actual market price. That’s where Automated Market Makers (AMMs) come in.
AMMs are part of this revolutionary thing called decentralized finance (DeFi). What they do is allow tokenized RWAs be traded automatically using pools of liquidity instead of the usual setup with buyers and sellers (order books and matching engines). People using AMMs contribute their tokens to these pools, and the prices are set by a constant math formula (algorithm). It’s like a high-tech way of making sure cryptocurrency exchanges are fair and smooth.
The system involves something called a “liquidity pool,” which is like a storage space for pairs of tokens. But how do these pools come about and stay active? Well, individuals or groups called “liquidity providers'' create” and support these pools by putting tokens into them.
But what’s in it for liquidity providers? Well, in return for contributing tokens, liquidity providers make money from the fees charged for the trades that involve the pool. These
liquidity providers receive rewards based on a set rule written into smart contracts (like Uniswap V2, where 0.3% of the trading fees go to liquidity providers), and these contracts run on the blockchain.
So, looking at all the rules we talked about for AMMs, it’s kind of like the regular ways we trade things, but also pretty different in that it does not require a central authority. It’s faster, decentralized, and gives a surefire way to swap digital assets fairly, speedily and easily.
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