The automatic market maker (AMM) is one of the great innovations of dex. It solves the liquidity problem on the chain. Many people have made many explorations on liquidity market making from order book market making to automatic market making. What is the difference between AMM and order book? The author mainly summarizes the following differences:
1. As long as the price returns, AMM are capital-guaranteed tradings
Traditional market makers generally use poor information or technical analysis to sell high and buy low, which is essentially an arbitrage behavior. However, the final loss/gain of AMM must be zero deducting transaction fees, but traditional market makers by order book may also earn the difference value in price fluctuations. For example, if AMM sells Ethereum at 1000$, then it must buy Ethereum at 1000$, while the traditional market makers may sell Ethereum at 1000$. And buy at 900$, of which 1000$-900$=100$ is your profit, of course, you may also buy back Ethereum at 1050$, which will lead to the failure of market making and a loss of 50$. And there must be no losing trades or profitable trades except trading fees for the AMM if the price returns back. All trades are capital-guaranteed.
2. AMM has no any spreads
AMM can trade at any price, while orders for traditional order books can only be submitted at the minimum price tick size of the system. For example, the minimum tick size of Bitcoin on many exchanges is 0.5$. To meet this requirement, your transaction price cannot be 30000.1$ or 30000.6$. However automated market makers can trade at any price like 30000.0000002$.
3. The price of AMM is automatically matched by the algorithm, and the price of the order book is determined by the orders
As we all know, decentralized exchanges cannot place and cancel orders frequently due to the limited performance of the blockchain. The automatic market making model can not only solve the liquidity problem, but also greatly reduce the dependence on computing efficiency. The price discovery of traditional order books is determined by active pending orders. Recently dex has a tendency to move closer to the order book with the emergence of uniswap V3. It is a new type of automatic market maker between traditional automatic market makers and order books. As long as the price can return to the starting point, all transactions are guaranteed. Of course, you can also remove liquidity, which is similar to the order cancer for the traditional order book, wait for the price to move to a suitable position, and then re-place the order to earn the difference value of price fluctuations.