Digital asset price calculation can be a headache for investors as it is quite a tough task done by humans, so here we need an algorithmic solution that would be responsible for calculating the price of digital assets, so we can eliminate the human market makers.
In this article, we will discuss a protocol that is responsible for determining the digital asset price so let’s get started!
What Are Automated Market Makers (AMMs)?
An automated market is a decentralized exchange (DEX) used to conduct the selling and buying of an asset using a protocol called Automated Market Maker (AMMs). This algorithmic protocol makes productive decisions about the product’s market value rather than human market makers. These algorithmic protocols use mathematical formulas to calculate asset prices based on supply and demand rather than relying on human market makers to set prices or conventional order books.
Supply and demand can vary depending on the specific algorithm and platform. The asset price could be determined by the Constant Function Market Maker (CFMM) and Logarithmic Market Maker (LMM).
Let's discuss Constant Function Market Maker (CFMM) and Logarithmic Market Maker (LMM) and how they are used to calculate the asset price!
Determining Asset Price Using Constant Function Market Maker (CFMM)
It is the type of (AMMs) and it determines the price of an asset using a constant product formula:
| P = k / S |
Where “P” is the asset's price, “k” is a constant, and “S” is its supply.
Determining Asset Price Using Constant Logarithmic Market Maker (LMM)
This is another type of (AMMs) and It determines asset prices using a logarithmic function:
| a * ln(S) + b = P |
Where “P” denotes the asset's price, “S” its supply, and “a” and “b” are coefficients determined by market conditions.
How Do Automated Market Makers (AMMs) Work?
In (AMMs) all the transactions are done by a smart contract, which contains a set of instructions when the required condition is met it would be automatically executed. As well as, the asset value could be determined by the CFMM and LMM as we discussed in the above sections. Let’s discuss more the working of Automated Market Makers (AMMs):
- Pool Creation: A pool contains a variety of digital assets; a user can create it and then can also add it to the AMMs.
- Price Calculation: Once the digital asset is added into the AMMs successfully. The next step would be taken by the AMMs, which would calculate the price of an asset using mathematical formulas (CFMM, LMM).
- Trading: Users can then trade the assets in the pool by giving or withdrawing liquidity.
- Profit Sharing: Some AMM feature a profit-sharing concept in which members that offer liquidity to the pool can receive a percentage of the platform's trading fees.
- Continuous Updates: AMM provides nonstop updates about the current market price of an asset.
Examples of Automated Market Makers (AMMs)
A few examples of Automated Market Makers (AMMs) are
- Uniswap
- SushiSwap
- Bancor
- Aave
- Yearn Finance
- Curve
- Balancer
Advantages of Automated Market Makers (AMMs)
- Decentralization
- 24/7 Availability
- Lower Fee
- Liquidity
- Accessibility
Disadvantages of Automated Market Makers (AMMs)
- Lack Of Regulation
- Complexity
- Volatility
- Dependence of Liquidity Provider
Conclusion
AMM uses algorithms to enable the creation of a decentralized exchange that operates 24/7, it calculates the product price using mathematical formulas based on product supply and market demand rather than the human market makers. We can say AMM is the smart decision maker about the digital assets and it eliminates the human decisions about the product. Furthermore, This results in a more efficient and accessible marketplace for purchasing and selling goods, especially in the world of cryptocurrencies and digital assets.
