AMM Revolution: How to Redefine the Cryptocurrency Trading Ecosystem

From Order Book to Liquidity Pool: The Transformation of Trading

Traditional exchanges rely on order books to match buyers and sellers, but Automated Market Maker (AMM) protocols have broken this model. AMMs use mathematical algorithms instead of manual matching to provide quotes directly from liquidity pools. This shift may seem like a technical detail, but it fundamentally disrupts the infrastructure of trading.

Around 2017, Bancor pioneered the introduction of the AMM concept in the blockchain space, but the true explosion came with the launch of Uniswap in 2018. Uniswap simplified complex market-making logic into code, allowing anyone to become a liquidity provider. This innovation completely rewrote the rules of decentralized trading.

The Core Logic of AMM: Anyone Can Be a Market Maker

In traditional finance, market makers are a select few elites—requiring huge capital, precise pricing ability, and risk tolerance. AMMs democratized this role.

In an AMM, users only need to deposit two tokens in proportion into a liquidity pool to earn a share of transaction fees. The system automatically adjusts token prices using mathematical formulas (like x*y=k), without human intervention. The higher the trading volume, the greater the earnings for liquidity providers. This model has attracted millions of ordinary users, significantly increasing market liquidity.

From the Margins of DeFi to the Market Center

The emergence of AMMs marks a turning point in decentralized finance. Platforms like Uniswap have experienced trading volumes that temporarily surpass some large centralized exchanges. This is not accidental but a market vote for more open and transparent trading methods.

Why do AMMs stand out in competition? The key points are:

Low Entry Barriers: No complex KYC processes; any wallet address can trade and provide liquidity

High Transparency: All transactions are publicly recorded on the blockchain, verifiable by anyone

Clear Revenue Mechanism: Market-making profits are directly linked to trading volume, aligning incentives

These features make AMMs the cornerstone of the DeFi ecosystem, laying the foundation for complex financial products like lending, derivatives, and insurance.

Invisible Costs: Hedging Impermanent Loss

Every mechanism has costs. The biggest risk faced by AMMs is Impermanent Loss. When token prices in the liquidity pool fluctuate sharply, the earnings of market makers may be offset or even result in losses due to price changes.

For example, if you deposit equal values of ETH and USDT into a liquidity pool, and ETH’s price doubles, the loss from impermanent loss could exceed the fee earnings.

To address this challenge, the industry is exploring new solutions:

• Dynamic Fees: Adjust fees based on market volatility, increasing fees during high volatility to compensate for risks
• Synthetic Asset Integration: Combine derivatives mechanisms to hedge against price risks
• Cross-Chain AMMs: Improve capital efficiency and reduce risk concentration on a single chain

The Future of AMM: From Trading to Financial Infrastructure

Currently, AMMs are mainly used for spot trading, but their potential extends far beyond. The industry is expanding the application boundaries of AMMs:

• Linking with lending protocols, where AMM liquidity can serve as collateral
• Integrating with options and futures platforms, making AMMs risk bearers for derivatives
• Acting as price discoverers and liquidity hubs in cross-chain bridges

These integrations not only enhance the utility of individual AMMs but also reshape the entire DeFi ecosystem architecture.

Conclusion: AMMs Are Inevitable

From niche technical experiments to mainstream market applications, AMMs have completed a decades-long evolution in just five years. They demonstrate a key insight: when trading is sufficiently transparent, participation is open, and incentives are clear, markets will spontaneously generate liquidity.

With the improvement of blockchain infrastructure and deeper user education, the scope of AMM applications will continue to expand. It has not only changed the form of exchanges but also fundamentally altered our understanding of “markets”—in the on-chain world, markets are no longer centralized venues but protocols anyone can participate in.