Automated Market Makers or AMMs encourage users to transform into liquidity providers in lieu of free tokens and transaction fees.
Decentralized exchanges use AMMs as the underlying protocol with the mechanism of autonomous trading. Thus, there is no requirement for centralized authorities, such as financial entities and exchanges. To cut it short, it enables two users to do asset transactions without the need for an intermediary authority to facilitate the exchange.
Defining a market maker
A market maker is typically a liquidity provider. Liquidity, in trading, means how seamlessly and fast an asset can be sold or purchased. For instance, a trader wishes to purchase one bitcoin. A centralized exchange, which monitors the trade, offers an automated system to search for a seller. The trader is ready to sell his/her bitcoin at the rate the other trader quotes. The exchange is functioning as an intermediary in this transaction.
What happens if there is no trader selling the bitcoin that satisfied the buy order of the buyer? The asset’s liquidity (bitcoin) is low in this scenario. It signifies that the asset has less trading activity. Also, it is more difficult to sell or purchase it.
When does a central exchange need market makers?
This is precisely the scenario where a centralized exchange requires market makers. Some professional traders or financial institutions offer liquidity by generating multiple sell/buy orders. It is to match the retail investors’ orders. The entity, which offers liquidity is referred to as market makers.
The goal of AMMs is to remove the presence of an intermediary while there is a trading of digital assets. These are a part of DEXs or decentralized exchanges that automate the procedure of providing liquidity.