Automated Market Makers and Decentralized Exchanges: a DeFi Primer

Automated market makers and decentralized exchanges: a DeFi primer. Financial Innovation 8, 20 (2022). https://doi.org/10.1186/s40854-021-00314-5

56 Pages Posted: 1 Dec 2020 Last revised: 18 Feb 2022

Date Written: October 30, 2020

Abstract

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 paper also looks at the impact of introducing concentrated liquidity in an AMM. Overall, the framework presented here provides an intuitive geometric representation of how an AMM operates, and a clear delineation of the similarities and differences across 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

Mohan, Vijay, Automated Market Makers and Decentralized Exchanges: a DeFi Primer (October 30, 2020). Automated market makers and decentralized exchanges: a DeFi primer. Financial Innovation 8, 20 (2022). https://doi.org/10.1186/s40854-021-00314-5, Available at SSRN: https://ssrn.com/abstract=3722714 or http://dx.doi.org/10.2139/ssrn.3722714

Vijay Mohan (Contact Author)

RMIT University ( email )

124 La Trobe Street
Melbourne, 3000
Australia

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