Here we will talk in more details about the AMM DEX protocol, which automatically calculates the cost of your assets and turns the decentralized exchange into a convenient currency exchange office.
Simply put, an AMM (automated market maker) is a robot that quotes a price for an asset. This is the price for which you can buy or sell this particular asset. This robot also gives you access to the liquidity pools and, consequently, to the cryptoassets available to exchange.
On the centralized exchanges (CEX), the price of the asset is determined by the sellers and buyers: the sellers set a price for the sale of their assets, and the buyers set a price for the purchase of the assets. When these two prices match, the exchange conducts the transaction.
Unlike on a CEX, the price of assets on an AMM DEX is not determined by the sellers or buyers, but by an algorithm. As a matter of fact, the transactions on an AMM are not performed between the buyer and the seller, but between the buyer and the smart contract or between the seller and the smart contract. Accordingly, the smart contract needs to calculate the price at which it is possible to buy and sell the assets at the given moment, including its own fee. This is the job of the algorithm, which calculates the current price of the asset according to certain rules. Then it is up to you to agree to sell or purchase the asset at the price offered by the smart contract.
Where can an AMM find assets if there is no counter order from another person? In this case, the assets are offered by liquidity providers for a certain fee. But we’ll talk about this next time.