TRADITIONAL MARKET MAKER
A traditional centralized exchange facilitates liquidity of trading pairs. through a central order book system that ensures trading orders are matched.
For example, Trader A decides to buy 1 BTC for $20,000 and places a buy order to the centralized exchange. The centralized exchange will match the buy order with the sell order placed by Trader B who is willing to sell 1 BTC at $20,000. Simply put, it functions as a middleman between traders. Its job is to ensure that this process is done quickly and seamlessly.
If the exchange is unable to find suitable matches for buy and sell orders quickly, we can say that the liquidity of the assets is low. Liquidity, in the context of trading, refers to how easily an asset can be bought or sold. High liquidity would suggest that there are many participants in the market buying and selling a particular asset and that the market is active, whereas low liquidity would suggest the converse, where there is little market activity, and it would be much harder to buy or sell an asset.
When liquidity is low, slippage occurs, in which the price of an asset at the point of executing a trade differs considerably before the trade is completed. This can occur often in volatile markets. Hence, exchanges must ensure that transactions are executed instantaneously to reduce price slippages.
Centralised exchanges often rely on professional traders or financial institutions to provide liquidity for the trading pairs. These entities create different bid/ask orders to match the orders of traders, ensuring that there are counterparties available for all trades. In this system, the liquidity providers take up the role of market makers. The market makers facilitate the processes required to provide liquidity for the trading pairs.
AUTOMATIC MARKET MAKER
Automated market makers (AMMs) are part of the decentralized finance (DeFi) ecosystem. They allow digital assets to be traded in an automatic way by using liquidity pools rather than a traditional market of buyers and sellers. Instead of using an order book like a traditional exchange, assets are priced according to a pricing algorithm.
Trading pairs you would normally find on a centralized exchange exist as individual “liquidity pools” in AMMs. For example, if you wanted to trade ether (ETH) for USD Coin (USDC), you would need to find an ETH/USDC liquidity pool.
Instead of using dedicated market makers, anyone can provide liquidity to these pools by depositing both assets represented in the pool. For example, if you wanted to become a liquidity provider for an ETH/USDC pool, you’d just need to deposit a certain predetermined ratio of ETH 、 USDC.
As a liquidity provider (LP), you can earn fees when traders interact with the pool by buying or selling the assets. For example, if your deposit represents X% of the liquidity locked in a pool, you will receive an LP token which represents X% of the accrued transaction fees of that pool. When a liquidity provider wishes to exit from a pool, they redeem their LP token and receive their share of transaction fees.
Key differences between Traditional and Automated Market Maker
| Traditional Market Maker | Automated Market Maker | |
| Counterparty | Requires buyer and seller of trading pair to be matched | Buyer/seller trade directly against the liquidity pool |
| Liquidity Provision | Rely on professional traders or financial institutions to act as counterparty | Rely on any liquidity providers to provide liquidity |
| Price Continuity | Prone to price slippage when liquidity is low | Ensures pricing continuity of trading pairs |
關於 DigiFT
DigiFT aims to provide regulated decentralized finance solutions on the Ethereum public blockchain. We are operating the first regulation-abiding decentralized digital asset exchange where asset owners can issue blockchain-based security tokens and investors can trade with continuous liquidity via an Automatic Market Maker mechanism. We are a global outfit backed by well-established venture partners. The founding team originates from Goldman Sachs, UBS, Citibank, and Morgan Stanley, and has deep blockchain technology knowledge, having successfully developed digital asset exchange and products in the past.
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