How DeFi’s Automated Market Makers Avoid Constricted Sets
Automated market makers, such as Uniswap, enable perfect matchings to occur between those who choose to swap one currency into another currency, by holding liquidity in both pools. Uniswap’s research team has algorithmically determined what the market clearing prices would be and accordingly priced the assets; in this case, this mechanism enables users to effectively swap between currencies at any given time, which is their competitive advantage in the Defi space. Uniswap’s liquidity pool, funded by their liquidity providers and stakers in the individual ecosystems, provides anyone in the world with access to critical financial tokens at rapid speeds and avoids the large processing fees embedded in traditional financial models.
In traditional systems, there is not always liquidity presently available to perform the transaction one requests, such as an account withdrawal or currency swap, especially in emerging markets where banking protocols are less regulated. Moreover, historically, a market needs buyers and sellers to form a necessary transaction, which at times, could be incredibly difficult to complete.
Thus, to resolve this issue, Uniswap purchased massive reserves of numerous tokens, such as Ethereum, to always have liquidity available for those seeking an instantaneous swap of currencies. Given the decentralized nature of Uniswap, there is no order book per se that monitors and tracks personal details of the tradings that occur on the platform. Thus, anyone across the globe has access to participating in Uniswap’s ecosystem and can share the same experience as anyone else. However, given the rising demand for the tool, Uniswap has intentionally had to increase its liquidity pool and incentivize its liquidity providers to participate in their ecosystem to avoid constricted sets and ensure that they can still create these perfect matchings for those seeking to use their platform. In this ecosystem, they provide users with interest on their own currencies if they deposit them into greater liquidity, which can be used for swapping and trading on their platform.
My source of inspiration: https://uniswap.org/