What is Automated Market Maker (AMM)?

Maciej Zieliński

07 Oct 2021
What is Automated Market Maker (AMM)?

Forget order books, the future of Decentralized Exchanges lies in Automated Market Makers. Automated Market Maker AMM enables traders to earn shares of transactions in exchange for becoming liquidity providers. What does it mean for DEXs? 

In this article you will learn:

  • What are Automated Market Makers?
  • How does Automated Market Maker work?
  • AMM vs On-chain / Off-chain order book 
  • How to implement liquidity pools into your DEXs
  • Why are Automated Makers so important for the whole DeFi ecosystem?

Automated Market Makers were first introduced to the public with the release of Uniswap in 2018. 

Essentially, they are autonomous trading machines that replace traditional order books with liquidity pools run by algorithms. 

What are Automated Market Makers?

As we mentioned in one of our previous articles, a decentralized exchange can handle trading in three ways:

  • On-chain order book
  • Off-chain order book
  • Automated Market Maker AMM

The last one is undoubtedly the most efficient. That's why the vast majority of modern decentralized exchanges are based on it.

Definition:

Automated Market Maker AMM is a decentralized exchange protocol that relies on smart contracts to set the price of digital assets and provide liquidity.

Cryptocurrency assets are priced according to a pricing algorithm and mathematical formula, instead of the order book that is used by traditional exchanges.

The mathematical formula varies from protocol to protocol. Uniswap, for example, uses the following formula:

a * b = k

Where 'a' and 'b' are the number of tokens traded in the liquidity pool. Since 'k' is constant, the  total liquidity of the pool must always remain the same. Different AMMS use various formulas. However, all of them set the price algorithmically. 

What's important, Automated Market Makers allow almost anyone create a market using blockchain technology.

How Automated Market Makers work?

For trading pairs, for example, BTC/ETH, Automated Market Makers work similarly to order books, which are based on buy and sell orders. However, a vital difference is that a trading pair isn't needed to make a trade. Alternatively, users can interact with a smart contract that will constitute the other side of the trading pair for them. This is what the term “automated market-making” refers to. 

P2P and P2C

You are probably familiar with the term “peer-to-peer transactions,” which is crucial to understanding decentralized exchanges. Every transaction that runs between two users without any intermediary can be called P2P. 

We can think about Automated Market Makers as peer-to-contract solutions because trades take place between users and a smart contract. 

Liquidity pools

Trading pairs, which you know from Centralized Exchange and Decentralized Exchange using order books, are an individual liquidity pool in Automated Market Maker. Therefore, users are essentially trading funds with liquidity pools, rather than with other users. 

If you want to trade two tokens, for example, sell BNB for Ether, you need to find the BNB/ETH liquidity pool. 

We can imagine a liquidity pool as a large pile of assets. But where do they come from?

Liquidity providers 

The answer might sound quite surprising: funds are added to liquidity pools by the users of the exchange. Or, more precisely, liquidity providers.

In exchange for providing liquidity, liquidity providers earn fees on transactions in their pool. Unlike traditional market making with professional market makers, here anyone can become one. 

Profits for liquidity

To become a liquidity provider you need to deposit both assets represented in the pool. Adding funds to the liquidity pool is not difficult and rewards are worth considering. The profits of liquidity providers differ depending on the platform. For instance, on Uniswap 0,3% of every transaction goes to liquidity providers.

Slippage on Automated Market Makers

Different Automated Market Makers may encounter different issues. Yet the risk of slippage is something we should always keep in mind while planning our own DEX. 

Why does it occur?

As I mentioned earlier, asset pricing is determined by an algorithm and a mathematical formula. We can say that it's determined by the ratio between the assets in the liquidity pool. Or more specifically, it is the change in this ratio that occurs after a trade. The larger the transaction, the wider the margin of change, and the greater the amount of slippage. 

Indeed, when a large order is placed in AMMs and a sizable amount of coin is removed or added to a liquidity pool, it can even cause a notable difference between the market price and the pool price. 

More liquidity = less slippage 

In the Automated Market Maker model, more liquidity means less slippage that large orders may incur. Ultimately, this may attract more volume to your DEX. That's why if you want to use Automated Market Maker on your platform, you need to have a solid strategy for encouraging your users to deposit funds in liquidity pools.

You need to remember that to stay competitive in the decentralized finance market, you should offer liquidity of at least a sufficient level. 

Generally, exchanges decide on sharing profits generated by trading fees with liquidity providers. In some cases (e. g. Uniswap), all the fees go to liquidity providers. If a user's deposit represents 5% of the assets locked in a pool, they will receive an equivalent of 5% of that pool’s accrued trading fees. The profit will be paid out in liquidity provider tokens. When users want to leave the pool, they simply exchange their tokens for their share of transaction fees. 

Yield Farming

Yield farming is one of the most important opportunities that can attract new users to your DEX platform. How does it work? What does it even mean? 

LP tokens

We often say that liquidity has a pivotal value in the DeFi space. Creating tokens that are awarded in exchange for providing liquidity is a great idea to increase it. 

Normally when a token is staked or deposited somehow, it cannot be used or traded, which decreases liquidity in the whole system. In the case of Automated Market Makers, implementing easily convertible liquidity provider tokens solves the problem of locked liquidity. Their mechanism is simple: users get them as proof of owing tokens that they have deposited. 

With LP tokens, each token can be used multiple times, despite being invested in one of the liquidity pools. Additionally, we can say that LP tokens open up a new, indirect form of staking. This means that instead of staking tokens themselves we just prove that we own them. 

What is Yield Farming? 

Yes, on multiple exchanges users can stake their LP tokens and profit from them. Essentially, this is what we call yield farming. The main idea behind it is to maximize profits by moving tokens in and out of different DeFi protocols.

How does it work on DEXs? 

Actually, from the user perspective it's quite simple:

  • deposit assets into a liquidity pool 
  • collect LP tokens
  • deposit or stake LP tokens into a separate lending protocol
  • earn profit from both protocols 

Note: You must exchange your LP tokens to withdraw your shares from the initial liquidity pool.

What is impermanent loss?

Impermanent loss occurs when the price ratio of two assets changes after traders deposit them in the pool. The higher the shift in price, the more significant the impermanent loss. Impermanent loss mostly affects liquidity pools with highly volatile assets. 

However, this loss is impermanent: there is a probability that the price ratio will revert. Permanent losses can only occur if liquidity providers withdraw their digital assets before the price ratio reverts. 

Conclusion 

Of all the solutions that we can currently observe on decentralized exchanges, the Automated Market Maker offers the highest liquidity. Today most DEXs are running on AMM or plan to implement it in the nearest future. That's why Automated Market Maker has crucial importance for the DeFi ecosystem.Do you want to know how to apply Automated Market Maker in your project? Don't hesitate to ask our specialists for a free consultation.

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The Economy of Aleph Zero (AZERO)

Karolina

22 Feb 2024
The Economy of Aleph Zero (AZERO)

The evolution of blockchain technology has brought forward numerous platforms aiming to solve various challenges in the digital world. Among these innovations, Aleph Zero stands out with its unique approach to creating an economically viable ecosystem through thoughtful tokenomics and incentives. This article delves into the economy of Aleph Zero, focusing on its native token, AZERO, to understand how it sustains growth, incentivizes participation, and ensures long-term viability.

MUST READ: "What is Aleph Zero"

Understanding AZERO Tokenomics

Key Metrics and Distribution

  • Ticker: AZERO
  • Type: Utility
  • Circulating Supply: 257,990,631
  • Total Supply: 354,678,137
  • % Staked: 71%
  • # of Wallets: 207,370
  • Inflation: 30,000,000 AZERO per year
  • Market Cap: $410,598,781

Allocation and Use Cases

  • Aleph Zero Foundation. 23% of the tokens are allocated for research, development, marketing, operations, ecosystem incentives, and other expenses.
  • Team Allocation. 10% of the tokens, with 80% locked for one year and vested over four years.
  • Funding Rounds. Details on the pre-seed, seed, Early Community round, public presale, and public sale distributions.
  • AZERO Utility. The AZERO coin powers the Aleph Zero ecosystem by being used for validator node staking, DEX swap fees, collateral for wrapped assets in Liminal, fees for asset-wrapping and bridging on Liminal, network fees, and governance voting processes.

The Role of Inflation in Aleph Zero's Ecosystem

Inflation is often viewed negatively in traditional economic contexts, associated with diminishing purchasing power and economic instability. However, in the realm of blockchain ecosystems like Aleph Zero, inflation serves as a pivotal mechanism for fostering sustainable growth, incentivizing network participation, and ensuring the long-term viability of the platform. This article explores the nuanced role of inflation within Aleph Zero's ecosystem, detailing its introduction, benefits, and governance.

Introduction of Inflation

Aleph Zero has introduced a systematic annual increase of 30 million AZERO tokens to its circulating supply, a decision rooted in the desire to sustain and nurture ecosystem growth. This inflationary mechanism is not merely a tool for increasing token supply but a strategic approach to enhancing the network's security, scalability, and development. By carefully calibrating the rate of inflation, Aleph Zero aims to balance the need for rewarding network participants with the imperative of maintaining the token's value over time.

Benefits of Inflation

The introduction of inflation within Aleph Zero's ecosystem serves multiple critical functions, each contributing to the platform's overarching goals:

  • Incentivizing Validators and Nominators. Validators and nominators play a crucial role in securing the Aleph Zero network through the proof-of-stake consensus mechanism. Inflation provides these participants with financial rewards for their efforts, encouraging continued engagement and investment in the network's health and security.
  • Funding Ecosystem Treasury. A portion of the newly minted AZERO tokens is allocated to the ecosystem treasury each year. These funds are instrumental in supporting ongoing development projects, marketing initiatives, operational expenses, and other activities that contribute to the ecosystem's growth and sustainability.
  • Supporting Long-Term Holding. By distributing inflation rewards primarily to those who stake their tokens, Aleph Zero encourages long-term holding over speculative trading. This strategy aims to reduce market volatility and foster a stable economic environment conducive to gradual growth.
https://youtu.be/y-FypMbm0BM

Inflation Mechanism and Governance

Validators and Nominators

At the heart of Aleph Zero's security and efficiency are its validators and nominators, who ensure the integrity of transactions and the network at large. Inflation directly supports these roles by compensating participants for their staked tokens and the risks associated with securing the network. This compensation not only rewards current participants but also attracts new validators and nominators, enhancing the network's decentralization and resilience.

Ecosystem Treasury

The ecosystem treasury represents a vital component of Aleph Zero's inflation strategy, receiving a dedicated portion of the annual inflation to fund various initiatives. These initiatives range from research and development to community engagement programs, all aimed at bolstering the ecosystem's health and competitiveness. The treasury's role is pivotal in allocating resources efficiently to areas that promise the most significant impact on Aleph Zero's growth and user adoption.

Decentralized Governance

A key aspect of Aleph Zero's inflationary policy is its commitment to decentralized governance. The platform envisions a future where token holders can vote on critical decisions, including adjustments to the inflation rate. This participatory approach ensures that the inflation mechanism remains responsive to the ecosystem's evolving needs, balancing the interests of various stakeholders to support the platform's long-term success.

MUST READ: "Aleph Zero vs Solana"

Regulatory Compliance and Market Presence

  • FINMA No-Action Letter: Aleph Zero’s compliance with Swiss law and the implications for its operation and token issuance.
  • Market and Wallets: Insights into Aleph Zero’s market presence, including exchanges and wallet statistics.

Key Takeaways

Conclusion

The economy of Aleph Zero showcases a thoughtful approach to creating a sustainable and growing blockchain ecosystem. Through strategic token allocation Aleph Zero is poised to contribute significantly to the blockchain landscape. As the platform evolves, its economic strategies will likely serve as a benchmark for future blockchain projects.

If you are interested in utilizing Aleph Zero, Solana or other blockchain-based solutions for your project, please reach out to contact@nextrope.com

FAQ

How is the AZERO token distribution structured?

  • The distribution is designed to support the ecosystem's growth, with allocations for stakeholders and strategic initiatives.

What role does inflation play in the Aleph Zero ecosystem?

  • Inflation is used strategically to incentivize network participation and ensure sustainability.

What is the utility of AZERO tokens within the Aleph Zero ecosystem?

  • AZERO tokens power the Aleph Zero ecosystem (validator node staking, DEX swap fees, collateral for wrapped assets in Liminal, fees for asset-wrapping and bridging on Liminal, network fees, and governance voting processes).

How does Aleph Zero handle inflation and its impact on the ecosystem?

  • Aleph Zero introduces a systematic annual increase of 30 million AZERO tokens to encourage ecosystem growth, incentivize participation, fund the ecosystem treasury, and support long-term holding by distributing inflation rewards mainly to stakers, aiming to balance growth with token value maintenance.

Aleph Zero vs Solana: A Comparative Analysis

Karolina

22 Feb 2024
Aleph Zero vs Solana: A Comparative Analysis

Blockchain ensures unparalleled security, transparency, and efficiency across various sectors. Within this innovative landscape, Aleph Zero and Solana have carved their niches, emerging as leading blockchain platforms. This article delves into a comparative analysis 'Aleph Zero vs Solana', aiming to illuminate their distinct features, technological advancements, and potential applications.

Understanding the Basics

Aleph Zero

ALEPH ZERO WHITEPAPER

  • Brief History and Development: Originating from a vision to enhance privacy and scalability in blockchain, Aleph Zero quickly ascended as a notable contender. Its development team focused on creating a platform that merges traditional blockchain benefits with advanced privacy features.
  • Core Technology and Consensus Mechanism: At its core, Aleph Zero utilizes a Directed Acyclic Graph (DAG) combined with a unique consensus algorithm. This innovative approach not only ensures transactions are processed swiftly but also maintains high security and privacy standards.

Solana

SOLANA WHITEPAPER

  • Brief History and Development: Solana was born from the ambition to solve the blockchain trilemma: achieving scalability, security, and decentralization without compromise. Its rapid growth is attributed to its ability to cater to high-demand applications, from decentralized finance (DeFi) to non-fungible tokens (NFTs).
  • Core Technology and Consensus Mechanism: Solana introduces the Proof of History (PoH) consensus mechanism, a groundbreaking innovation that allows for timestamping transactions in a sequential manner. This, combined with its underlying blockchain structure, enables Solana to process transactions at lightning speeds, setting new standards for efficiency in the blockchain domain.

The journeys of Aleph Zero and Solana, though distinct, converge on a shared goal: to redefine the capabilities of blockchain technology. Through their innovative approaches to consensus mechanisms and core technologies, both platforms offer unique solutions to the challenges facing traditional and digital markets today. Their contributions to the blockchain landscape not only highlight their individual strengths but also underscore the diverse potential of blockchain technology as a whole.

MUST READ: "What is Aleph Zero - Key Features"

Key Features Comparison - Aleph Zero vs Solana

Scalability

  • Aleph Zero: Tackles scalability through its DAG-based consensus, allowing parallel transactions that increase scalability.
  • Solana: Achieves high scalability with its PoH consensus, efficiently handling thousands of transactions per second (TPS).

Transaction Speed and Throughput

  • Aleph Zero: Boasts fast transaction speeds due to its lightweight consensus mechanism, aiming for efficiency without sacrificing security.
  • Solana: Known for its exceptional speed, Solana processes up to 65,000 TPS, setting a benchmark in blockchain throughput.

Fees

  • Aleph Zero: Offers low transaction fees, making it attractive for both high-volume transactions and micro-transactions.
  • Solana: Despite its high throughput, Solana maintains competitively low fees, further enhancing its appeal for developers and users alike.

Smart Contracts and DApp Development

  • Aleph Zero: Supports smart contracts and DApp development, focusing on privacy and scalability within its ecosystem.
  • Solana: Provides robust support for DApps and smart contracts, powered by its high-speed blockchain, ideal for complex applications.
Aleph Zero vs Solana

Use Cases - Aleph Zero vs Solana

Aleph Zero

  • Best Suited For: Privacy-focused applications, financial services requiring high security, and scalable enterprise solutions.

Solana

  • Shines In: High-frequency trading platforms, decentralized finance (DeFi) applications, and NFT marketplaces demanding fast transactions.

Performance Analysis

Network Speed and Efficiency

  • Aleph Zero: Demonstrates efficiency with its innovative consensus, ensuring quick and secure transactions.
  • Solana: Outpaces many with its network speed, attributed to the PoH mechanism, ensuring both rapid and consistent transaction processing.

Scalability Solutions

  • Aleph Zero: Continuously explores advancements in DAG technology to enhance its scalability solutions.
  • Solana: Plans to further optimize its infrastructure, ensuring it remains scalable amidst growing demand.

Security Aspects

Consensus Mechanisms

  • Aleph Zero: Its unique consensus mechanism prioritizes security, aiming to prevent attacks while maintaining speed.
  • Solana: Solana's PoH consensus is designed with security in mind, preventing double-spending and ensuring transaction integrity.

Known Vulnerabilities and Responses

  • Aleph Zero: Responds to vulnerabilities with timely updates, emphasizing its commitment to security and privacy.
  • Solana: Has faced challenges, including network congestions and DDoS attacks, but has responded with enhancements to its network resilience.

Through this comparative analysis, it becomes evident that Aleph Zero and Solana each bring distinctive strengths to the blockchain arena. Their approaches to scalability, transaction speed, fees, and smart contract capabilities cater to different needs within the blockchain ecosystem. Moreover, their targeted use cases and ongoing efforts to enhance performance and security underscore the dynamic and evolving nature of blockchain technology.

Conclusion

In conclusion, the comparative analysis between Aleph Zero vs Solana reveals two highly innovative and efficient blockchain platforms, each with its unique strengths. Aleph Zero focuses on privacy and scalability, making it ideal for applications requiring robust security measures. Solana, on the other hand, excels in transaction speed and throughput, positioning it as a top choice for high-frequency trading and DeFi applications.

If you are interested in utilizing Aleph Zero, Solana or other blockchain-based solutions for your project, please reach out to contact@nextrope.com

FAQ

What are the main differences between Aleph Zero and Solana's consensus mechanisms?

  • Aleph Zero uses a Directed Acyclic Graph (DAG) combined with a unique consensus algorithm for high security and privacy, while Solana employs Proof of History (PoH) for high-speed transaction processing.

How do Aleph Zero and Solana compare in terms of transaction speed and scalability?

  • Aleph Zero focuses on scalability with its DAG-based consensus allowing parallel transactions, while Solana is known for its exceptional speed, processing up to 65,000 transactions per second.

What are the targeted use cases for Aleph Zero and Solana?

  • Aleph Zero is best suited for privacy-focused applications and scalable enterprise solutions, whereas Solana excels in high-frequency trading platforms, decentralized finance (DeFi) applications, and NFT marketplaces.

How does the developer community size and support compare between Aleph Zero and Solana?

  • Readers might be curious about the size of the developer community, availability of development tools, and the level of support provided to developers in both ecosystems.

What are the environmental impacts of Aleph Zero vs. Solana?

  • Given increasing concerns about sustainability, potential users may question the energy consumption and environmental footprint of both blockchain platforms.