Day 19 — How Can You Trade Without an Order Book?

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Trading without an order book

An automated market maker, or AMM, lets people trade crypto without a traditional order book.

Instead of matching buyers with sellers, an AMM uses a liquidity pool and a pricing formula.

This is one reason decentralized exchanges can run directly on blockchains.

A liquidity pool holds two or more tokens inside a smart contract.

Users called liquidity providers deposit tokens into the pool. In return, they may earn trading fees.

When someone swaps tokens, they trade against the pool rather than another person.

Many basic AMMs use a simple idea often written as x*y=k.

If a trader removes one token from the pool, the pool charges more of the other token.

Therefore, large trades can move the price more. This effect is called slippage.

AMM prices can drift away from prices on other markets.

Arbitrage traders notice the gap. Then they trade until the AMM price comes closer to the wider market.

An automated market maker turns a smart contract into a simple trading venue.

It is open and useful, but traders still need to understand liquidity, slippage, and smart contract risk.