Automated Market Makers and Decentralized Exchanges: a DeFi Primer
54 Pages Posted: 1 Dec 2020 Last revised: 14 Apr 2021
Date Written: October 30, 2020
Recent advancements in decentralized finance (DeFi) have resulted in a rapid increase in the use of Automated Market Makers (AMMs) for creating decentralized exchanges (DEXs). In this paper, we organize these developments by treating an AMM as a neoclassical black-box characterized by the conversion of inputs (tokens) to outputs (prices). The conversion is governed by the technology of the AMM summarized by an ‘exchange function’. Various types of AMMs are examined, including: Constant Product Market Makers; Constant Mean Market Makers; Constant Sum Market Makers; Hybrid Function Market Makers; and, Dynamic Automated Market Makers. The use of traditional economic tools allows for an intuitive geometric representation of how an AMM operates. The unified framework also enables a clear delineation of the similarities and differences between the various types of AMMs.
Keywords: Decentralized Finance (DeFi), Automated Market Maker (AMM), Decentralized Exchange (DEX), Smart Contract, Ethereum
JEL Classification: D20, G20
Suggested Citation: Suggested Citation