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They make providing liquidity much simpler and cheaper
Automated market makers are an attempt to work around the performance restrictions of smart contract blockchains, especially Ethereum. Before AMMs came into prominence, decentralized exchanges built on Ethereum, like EtherDelta or 0x, attempted to use a classical order book mechanism.
However, they suffered from liquidity issues, as placing each order required spending gas and waiting for block confirmation times. Ethereum’s low throughput also meant that only a small number of transactions could be submitted before the blockchain would be completely swamped by these orders.
This was especially problematic for market makers, the liquidity providers on order book exchanges. “Making” a market typically requires constantly adjusting buy and sell orders to the latest price, even if they do not get filled. When each submitted order costs money and time, they may lose more than they gain from the bid-ask spread, which is the difference between the highest offered buy price and lowest sell price.
AMMs make providing liquidity cheaper and simpler through a completely automated one-time process — hence the name. Even average users can pitch in with their liquidity, while doing so on traditional exchanges requires advanced technical knowledge.
Automated market makers are an attempt to work around the performance restrictions of smart contract blockchains, especially Ethereum. Before AMMs came into prominence, decentralized exchanges built on Ethereum, like EtherDelta or 0x, attempted to use a classical order book mechanism.
However, they suffered from liquidity issues, as placing each order required spending gas and waiting for block confirmation times. Ethereum’s low throughput also meant that only a small number of transactions could be submitted before the blockchain would be completely swamped by these orders.
This was especially problematic for market makers, the liquidity providers on order book exchanges. “Making” a market typically requires constantly adjusting buy and sell orders to the latest price, even if they do not get filled. When each submitted order costs money and time, they may lose more than they gain from the bid-ask spread, which is the difference between the highest offered buy price and lowest sell price.
AMMs make providing liquidity cheaper and simpler through a completely automated one-time process — hence the name. Even average users can pitch in with their liquidity, while doing so on traditional exchanges requires advanced technical knowledge.