What is an Automatic Market Maker (AMM)?
An Automatic Market Maker (AMM) is a mathematical algorithm designed to determine the price of one or more assets based on supply and demand within a liquidity pool. It automates the process of making markets, allowing users to trade without needing a traditional order book.
There are several types of AMMs. Below, we will cover four of the most popular and widely-used types:
- Constant Product Market Maker (CPMM)
- Constant Sum Market Maker (CSMM)
- Constant Ratio Market Maker (CRMM)
- Constant Mean Market Maker (CMMM)
1. Constant Product Market Maker (CPMM)
Algorithm:
X * Y = K
Description:
This method ensures that the product of two assets in a liquidity pool remains constant. When the supply of one asset decreases, the price of the other increases to maintain the equation.
Pros:
- Simple to implement
- Commonly used (e.g., Uniswap)
Cons:
- High slippage in large trades
- Not ideal for large-volume transactions
2. Constant Sum Market Maker (CSMM)
Algorithm:
X + Y = K
Description:
This method ensures that the sum of two assets in the pool always remains constant, making it particularly useful for stablecoins where price volatility is minimal.
Pros:
- Zero slippage, ideal for stablecoin trading
Cons:
- Fails to handle large price fluctuations
- Can lead to arbitrage opportunities and manipulation
3. Constant Ratio Market Maker (CRMM)
Algorithm:
X^k * Y^{(1-k)} = Z
Description:
This method ensures that the ratio between two assets remains constant. For example, if the pool is set to always have 1 A token for every 2 B tokens, this ratio is maintained regardless of trades.
Pros:
- Flexible and can handle multiple assets
- Useful for creating liquidity tokens
Cons:
- Requires more complex rebalancing, especially with multiple assets
- Potential for higher fees due to complexity
4. Constant Mean Market Maker (CMMM)
Algorithm:
(X^k * ... * Y^{(1-k)}) = Z
Description:
This is an extended version of the CRMM, designed for pools with multiple assets. It maintains a constant ratio across all assets in the pool.
Pros:
- Same flexibility as CRMM, but for multiple assets
- Great for balancing complex portfolios
Cons:
- Similar challenges to CRMM: higher complexity and rebalancing costs
Other Types of AMMs
Hybrid Market Maker:
Combines multiple functions and parameters to achieve specific trading behaviors, allowing for more customization and efficiency.Order Book Market Maker (OBMM):
Maintains a fair and orderly market by placing buy and sell orders on an order book, unlike traditional AMMs which operate without order books.Dynamic Fee AMM:
Adjusts the fees dynamically based on market conditions to optimize liquidity and trading volume.