While AMM vs order book seems to be an improvement over the traditional order book model, it is far from superior. While the AMM system is easier to use, order books are more convenient for large trades. This is partly because of the transaction costs that order books have. But with a few improvements, AMM could prove to be a worthy competitor.
AMM was designed to accommodate market demands at the early stages of DeFi, when users wanted a simple trading product and easy promotion. As the market has grown, these basic functions have evolved and users demand more advanced services. As a result, the AMM mechanism is bound to be used by the DEX.
The key to maintaining stability and safety of the system is maintaining a balance between the long and short positions. If one side is weaker than the other, the order book will suffer. As a result, the base difference will increase, leading to poor user experience and increased system risk. As such, the exchange needs to implement a risk-control mechanism that will prevent these types of problems.
Automated Market Makers (AMM) have emerged as an alternative to order books in cryptocurrency exchanges. This new mechanism facilitates the swapping of token pairs on decentralized exchanges. First developed by Vitalik Buterin in his paper, AMM has gained momentum in several DeFi projects. An AMM uses a mathematical formula to determine asset prices. This information is then added to a pool of liquidity. This process constantly rebalances the liquidity pool as users trade in and out of the pool.
AMM provides the opportunity for general users to earn transaction fees. The system has the potential to transform how cryptocurrencies are traded. OneSwap uses an on-chain order book based on AMM. Its users can initiate market-order and limit-order transactions. They can also create target prices for their sell and buy orders. These features also increase digital currency liquidity.
Order books are generally the most common type of trading model in the traditional financial world, and they are well suited for centralized exchanges in the digital asset space. However, order books are also prone to varying liquidity levels, which affects the perpetual price. If liquidity is poor, the system can collapse and the user can be left with high costs.
AMMs are crucial components in liquidity pools. Prior to AMMs, liquidity was difficult. Having more liquidity means easier trading. AMMs make the process faster and more transparent. AMMs also facilitate smart contracts that provide liquidity to peers on a DEX. They are a great addition to DEXs.