Hence, exchanges must ensure that transactions are executed instantaneously to reduce price slippages. This often occurs in volatile terrains like the crypto market. In other words, the price of an asset at the point of executing a trade shifts considerably before the trade is completed. When liquidity is low, slippages tend to occur. Conversely, low liquidity means there is less activity and it is harder to buy and sell an asset. High liquidity suggests the market is active and there are lots of traders buying and selling a particular asset. Liquidity, in terms of trading, refers to how easily an asset can be bought and sold.
In such a scenario, we say that the liquidity of the assets in question is low. So, what happens if the exchange cannot find suitable matches for buy and sell orders instantaneously? Its job is to make the process as seamless as possible and match users’ buy and sell orders in record time. As such, the centralized exchange is more or less the middleman between Trader A and Trader B. In other words, when Trader A decides to buy 1 BTC at $34,000, the exchange ensures that it finds a Trader B that is willing to sell 1 BTC at Trader A’s preferred exchange rate. Related: A Beginner’s Guide to Atomic SwapsĪ centralized exchange oversees the operations of traders and provides an automated system that ensures trading orders are matched accordingly. In this guide, we will explore how automated market makers work.īut first, let us take a look at what are market makers. Simply put, they are autonomous trading mechanisms that eliminate the need for centralized exchanges and related market-making techniques. When Uniswap launched in 2018, it became the first decentralized platform to successfully utilize an automated market maker system.Īn automated market maker (AMM) is the underlying protocol that powers all decentralized exchanges (DEXs).
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