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

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 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

Mohan, Vijay, Automated Market Makers and Decentralized Exchanges: a DeFi Primer (October 30, 2020). 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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