What is an Automated Market Maker: An In-Depth Explanation

Yield farming</strong></a> has quickly become one of the more-popular methods of how people earn <strong>a passive income</strong> with their crypto. The concept itself is still a mystery to many, however - getting into yield farming can seem intimidating and confusing! That’s why I’ll try to strip the topic of any and all confusion, and tell you everything you need to know about yield farming.</p>\n<p>In this section, we’re analyzing yield farming. I’ll tell you what yield farming is, how it works, and how you can start farming cryptocurrency yield, as well!</p>\n<p>Let’s get to it!</p>\n<h2>What is Yield Farming?</h2>\n<p>So, then - what is yield farming?</p>\n<p>Well, the term consists of two words, so let’s break them down, shall we?</p>\n<p>“Yield” refers to passive rewards that you’d receive for participating in some sort of a process. The rewards are passive, since you don’t need to actively participate in said processes, all the time.</p>\n<p>In this context, “farming” simply means “<strong>continuous acquisition</strong>”. So, “yield farming” is simply a method of receiving passive profits (in the form of some asset) in a recurring manner. In principle, that’s pretty simple!</p>\n<p>When it comes to crypto, yield farming isn’t all that different. You invest some cryptocurrency into a project, and then start receiving passive periodic gains - in other words, it’s a way to make a passive income!</p>\n<p>Well, “invest” isn’t even necessarily the right term to use here, really. Rather, you would “lock” your crypto for some period of time. Allow me to illustrate with an example.</p>\n<p><img style=\"display: block; margin-left: auto; margin-right: auto;\" title=\"What is yield farming: Yield farming in crypto.\" src=https://www.bitdegree.org/"https://assets.bitdegree.org/crypto/storage/media/what-is-yield-farming-1.o.jpg/" alt=\"What is yield farming: Yield farming in crypto.\" width=\"1000\" height=\"654\" /></p>\n<p>Imagine that you have a bag of 10 candies. One day, your friend comes up to you, and makes you an offer - if you give him the bag for a week, he’ll bring you back 12 candies.</p>\n<p>Now, your friend WILL use the candies in your bag, in order to trade them with other people. However, by the end of the week, no matter what happens, you will still get 12 candies back.</p>\n<p>Do you really care that your friend will use the candies throughout the week? Does that matter at all? Not really - all that matters is that <strong>you’ll get all of your candies back</strong>, and more!</p>\n<p>This is, essentially, how yield farming works in crypto, too. Naturally, though, there are different types of yield farming that you could participate in! So, let’s check each of these types out, and try to figure out which is the most worthwhile, shall we?</p>\n<h2>Crypto Lending and Borrowing</h2>\n<p>The very first form of yield farming that you’ll likely come across is cryptocurrency lending and borrowing. This concept has become very popular throughout the last year or two!</p>\n<p>There are multiple decentralized finance projects that allow crypto fans to both borrow cryptocurrencies, as well as lend them - platforms such as <strong>AAVE,</strong> which are a great example of this.</p>\n<p>The most common way to participate in yield farming with such projects is to lend your crypto. Let’s say, you have 1 <a href=https://www.bitdegree.org/"/crypto/buy-bitcoin-btc/">Bitcoin, and aren’t planning on selling or trading it anytime soon.</p>\n<p>You would go to a platform such as AAVE, and lend that Bitcoin to someone else. Don’t worry, since the entire process is automated, and happens via special pools - there are minimal risks involved. If you’re not familiar with liquidity pools, though, I highly encourage you to read the section on the topic, in order to get a better understanding of the concept.</p>\n<p>Now, depending on a few different factors, you could expect to receive an <strong>APR (Annual Percentage Rate)</strong> of up to and over 34%. In other words, in a year, you would end up with 0,34 BTC more - that’s a huge number!</p>\n<p>To put it into context, with traditional banking institutions, your APR won’t really go over 1%. Well, you can probably see why crypto yield farming is as hot of a topic as it is!</p>\n<p><img style=\"display: block; margin-left: auto; margin-right: auto;\" title=\"What is yield farming: Lending.\" src=https://www.bitdegree.org/"https://assets.bitdegree.org/crypto/storage/media/what-is-yield-farming-2-62740da312491.o.jpg/" alt=\"What is yield farming: Lending.\" width=\"1000\" height=\"752\" /></p>\n<p>Another awesome feature of cryptocurrency lending is that, in most cases, you are able to withdraw your money at any point in time. So, if you DO end up needing that 1 Bitcoin, you can just take it out, with no strings attached.</p>\n<p>Next up, borrowing. This one’s a bit tricky, I’ll admit, since it’s one of the <strong>more-unique forms</strong> of yield farming.</p>\n<p>Imagine that you have a very old and valuable painting. You love that painting, spent a lot of time admiring it, and thus, don’t want to sell it! However, you’re in a bit of a pickle - you really need some money.</p>\n<p>What you could do is borrow money, while placing your painting as collateral for the loan. Once you pay the loan (+interest) back, you will get your painting back, too. Now, since the painting is so old and valuable, its price on the market will increase during that period of the loan.</p>\n<p>This is the general view of how yield farming works when you borrow cryptocurrencies. If you believe that Bitcoin is an awesome crypto, and it will rise in price, you could <strong>use it as collateral</strong> for your loan - then, you would have some money to work with, while also having BTC locked in as collateral, with the hopes that, once you repay your loan, that Bitcoin will be worth more than when you initially had it!</p>\n<p>Now, there is one more awesome method of how you could participate in yield farming while borrowing and lending your cryptocurrencies. However, it’s a bit more complex, so we’ll leave it for the end of the section, as a bonus - make sure to read it till the end!</p>\n<h2>Providing Liquidity</h2>\n<p>Moving on, the second big form of yield farming is becoming a liquidity provider. It sounds fancy, but the core idea behind this is very simple - in order to understand it as best as possible, however, you should really go and read the section on <a href=https://www.bitdegree.org/"/crypto/learn/what-is-liquidity-pool-in-crypto/">liquidity pools</strong></a> that I’ve mentioned earlier!</p>\n<p><strong>Liquidity providers</strong> are people that provide their money to decentralized cryptocurrency exchanges, and receive passive returns for doing so. Let’s say that you have a $1000 laying around, and want to make it “work for you”, so to speak. Well, to start off, you would first convert that money to two cryptocurrencies - let’s say, Ethereum and AAVE.</p>\n<p>Then, you would take your ETH and AAVE, and provide it to a decentralized exchange, such as Uniswap. People would then use your <a href=https://www.bitdegree.org/"/crypto/buy-ethereum-eth/">Ethereum and AAVE in order to swap from one cryptocurrency to another. Each of these swaps have fees!</p>\n<p>Now, the <strong>fees</strong> are collected by Uniswap, and distributed to the liquidity providers as payment for their liquidity. A very simple, yet super-effective model!</p>\n<p><img style=\"display: block; margin-left: auto; margin-right: auto;\" title=\"What is yield farming: Providing liquidity.\" src=https://www.bitdegree.org/"https://assets.bitdegree.org/crypto/storage/media/what-is-yield-farming-3.o.jpg/" alt=\"What is yield farming: Providing liquidity.\" width=\"1000\" height=\"522\" /></p>\n<p>Your actual passive gains will depend on a few different factors. First of all, the amount that you provide as liquidity, and how many other liquidity providers are in the same pool. If the ETH-AAVE pool is huge, and there are thousands of others providing liquidity, you’ll probably get a smaller return!</p>\n<p>However, if you provide the pool with a hefty sum of tokens, your returns will be much bigger, as well.</p>\n<p>Another thing to look out for are the fees that the decentralized exchange imposes. Depending on these fees, your reward will vary, as well! To this day, however, Uniswap remains the most popular decentralized exchange when it comes to <strong>providing liquidity</strong> and earning passive interest.</p>\n<h2>Staking</h2>\n<p>Continuing on with the section, the third method of how you can participate in yield farming is one that’s familiar to many cryptocurrency enthusiasts - <a href=https://www.bitdegree.org/"/crypto/learn/crypto-terms/what-is-staking/">staking.
/n
At first glance, staking can appear much the same as providing liquidity - you have some crypto coins or tokens, and provide them to a specific platform, in order to earn passive returns. I have to admit, going into the topic in-depth, things aren’t that simple - do check out the section on <a href=https://www.bitdegree.org/"/crypto/learn/what-is-staking-in-crypto/">staking, as well as the differences between <a href=https://www.bitdegree.org/"/crypto/learn/coin-vs-token/">coins and tokens</strong></a> if you’d like to learn more.</p>\n<p>For the sake of keeping this section about yield farming, though, let’s just say that staking is when you <strong>lock up your tokens</strong> in the network, in order for them to confirm other people’s transactions. Only specific coins can be staked - those that are built on the <a href=https://www.bitdegree.org/"/crypto/learn/crypto-terms/what-is-proof-of-stake-pos/">Proof-of-Stake consensus model!</p>\n<p><img style=\"display: block; margin-left: auto; margin-right: auto;\" title=\"What is yield farming: Proof-of-Stake.\" src=https://www.bitdegree.org/"https://assets.bitdegree.org/crypto/storage/media/what-is-yield-farming-4.o.jpg/" alt=\"What is yield farming: Proof-of-Stake.\" width=\"1000\" height=\"764\" /></p>\n<p>The simplest example of staking would be that of the Cardano project, and its native coin called ADA. You can purchase ADA on most top-rated cryptocurrency exchanges on the market, such as Binance or Coinbase. After you have your ADA coins, you would then need to find a staking pool - the simplest way to do this is to transfer your ADA into the Yoroi wallet - it’s a browser extension-based wallet, and is the most popular place where people store and keep their ADA coins. Also, Yoroi has multiple pools available to be accessed from within the <a href=https://www.bitdegree.org/"https://www.bitdegree.org/crypto/best-cryptocurrency-wallet/">wallet!
/n
All that you need to do is choose the pool that you want, and delegate <strong>your ADA coins</strong> into it. As time goes on, your coins will start earning passive returns for you!</p>\n<p>Admittedly, this is a topic that deserves a separate section, of its own.</p>\n<p><img style=\"display: block; margin-left: auto; margin-right: auto;\" title=\"What is yield farming: Staking = providing liquidity.\" src=https://www.bitdegree.org/"https://assets.bitdegree.org/crypto/storage/media/what-is-yield-farming-5.o.jpg/" alt=\"What is yield farming: Staking = providing liquidity.\" width=\"1000\" height=\"319\" /></p>\n<p>Another way how you can stake coins, and thus, farm yield, is on <a href=https://www.bitdegree.org/"https://www.bitdegree.org/crypto/best-cryptocurrency-exchange/">cryptocurrency exchanges</strong></a> themselves. Some of the most popular exchange platforms are beginning to offer their users staking functionality - you could purchase coins, and then simply stake them from within your exchange-based cryptocurrency wallet - there’s usually just one button to press, and that’s it!</p>\n<p><img style=\"display: block; margin-left: auto; margin-right: auto;\" title=\"What is yield farming: Staking coins.\" src=https://www.bitdegree.org/"https://assets.bitdegree.org/crypto/storage/media/what-is-yield-farming-6.o.jpg/" alt=\"What is yield farming: Staking coins.\" width=\"1000\" height=\"518\" /></p>\n<p>In most cases, your yield rewards will be the same tokens that you stake, or the so-called “LP tokens”, otherwise known as liquidity provider tokens. You will then be able to trade these LP tokens to another cryptocurrency, such as Ethereum.</p>\n<h2>Redistribution Fees</h2>\n<p>The last big method of how you can participate in yield farming is by holding cryptocurrencies that have <strong>redistribution fees</strong>.</p>\n<p>Sounds fancy? Well, it’s super-simple, really!</p>\n<p>Some cryptocurrencies have what are called “redistribution fees”. This means that, whenever you trade this crypto, a part of the fees that you pay for the trade will be distributed to other holders of this cryptocurrency.</p>\n<p>Probably the best-known example of this would be <strong>Safemoon</strong>. This is a very popular cryptocurrency that has redistribution fees, as well as token-<a href=https://www.bitdegree.org/"/crypto/learn/crypto-terms/what-is-burning/">burning mechanics.</p>\n<p>Token burning sounds pretty fancy, but it really is simple. As you transact with a cryptocurrency, you pay certain fees for your transactions, in the form of those same tokens - so, let’s say, if you want to send 10 Safemoon to your friend, that will cost you 1 Safemoon token, as a transaction fee.</p>\n<p><img style=\"display: block; margin-left: auto; margin-right: auto;\" title=\"What is yield farming: Safemoon example.\" src=https://www.bitdegree.org/"https://assets.bitdegree.org/crypto/storage/media/what-is-yield-farming-7.o.jpg/" alt=\"What is yield farming: Safemoon example.\" width=\"1000\" height=\"958\" /></p>\n<p>Some of those fees will be redistributed to token holders - say, they would share 0,5 of a Safemoon token. The other 0,5 Safemoon would be sent to an <strong>inactive, inaccessible wallet</strong>. This is what is called “token burning” - tokens in this wallet would be lost forever. This way, the token battles inflation, and still rewards holders!</p>\n<p>Now, obviously, there are various technicalities to be aware of, when it comes to this type of yield farming. The token may sway in price heavily, and you would need to have A LOT of tokens in order to receive any notable yield gains.</p>\n<h2>Leveraged Lending</h2>\n<p>So, with the four big, main yield farming methods out of the way, I’d also like to tell you about a bonus method. It’s called “leveraged lending” - I left it as a bonus because it’s a bit trickier than the other yield farming tactics we’ve discussed in this section.</p>\n<p>Imagine that you have $100 in ETH. You decide to lend the ETH, and borrow some <strong>DOGE coins</strong>, by putting your ETH up as collateral. Since your collateral will always need to be bigger than your loan, you receive $70 worth of Dogecoin in return.</p>\n<p>Now, what you would do is go to a cryptocurrency exchange, and trade in your Dogecoins for Ethereum. You now have ETH again! So, you take it back to the lending platform, put in your new ETH coins, and borrow some more Dogecoin - and repeat the process!</p>\n<p>Since your collateral will always be higher than your loan, this does have an endpoint. However, by the end, you’ll have much more ETH in the lending platform than you did at the beginning.</p>\n<p>This isn’t a very simple process to set up, since it requires knowledge of APRs, different lending and borrowing platforms, and great timing. Also, the prices of cryptocurrencies these days are <strong>rather volatile</strong>, and you might end up liquidating your positions, if the price of ETH drops too much. However, with a bit of practice, this can be a pretty interesting yield farming strategy!</p>\n<p>So, to conclude the section, I’d like to say that, when it comes to yield farming, there are multiple methods that you could employ, with varying degrees of risk and reward. In short, though, you should focus on the <strong>top-rated projects,</strong> and cryptocurrencies that have historically shown signs of resistance against large price swings and general market volatility.</p>","meta_title":"What is Yield Farming in Crypto: Yield Farming Explained","meta_description":"Find out what is yield farming in crypto and all of the important factors such as types of yield farming that you could participate in!","meta_keywords":"what is yield farming, yield farming crypto, yield farming explained, crypto yield farming, crypto farming","order":11,"language":"en","created_at":"2022-05-03T13:25:43.000000Z","updated_at":"2023-03-10T08:17:31.000000Z","modified_content":"<p>In this section, I will tell you what is yield farming in the field of crypto!</p>\n<p><a href=https://www.bitdegree.org/"/crypto/learn/crypto-terms/what-is-yield-farming/">Yield farming</strong></a> has quickly become one of the more-popular methods of how people earn <strong>a passive income</strong> with their crypto. The concept itself is still a mystery to many, however - getting into yield farming can seem intimidating and confusing! That’s why I’ll try to strip the topic of any and all confusion, and tell you everything you need to know about yield farming.</p>\n<p>In this section, we’re analyzing yield farming. I’ll tell you what yield farming is, how it works, and how you can start farming cryptocurrency yield, as well!</p>\n<p>Let’s get to it!</p>\n<div class=\"container\">\n <div class=\"row justify-content-center\">\n <div class=\"col-md-10 comparison-suggestion pb-3 mb-4\">\n <div class=\"d-flex flex-row\">\n <div class=\"text-center\">\n <div class=\"img-block-yt\">\n <img src=https://www.bitdegree.org/"https://assets.bitdegree.org/crypto/assets/images/compare-crypto-exchanges.gif/"/n alt=\"What is Yield Farming in Crypto? (Animated Explanation)\"\n title=\"What is Yield Farming in Crypto? (Animated Explanation)\" class=\"border-0\">\n <p>Video Explainer</p>\n </div>\n </div>\n <div class=\"col-xs-10 col-sm-10 col-md-10 text-left py-3 yt-info\">\n <h4 class=\"mb-1\">Video Explainer: The Main Yield Farming Techniques</h4>\n <p class=\"py-1 mb-0 youtube-video-subtitle\">Reading is not your thing? Watch the \"The Main Yield Farming Techniques\" video explainer</p>\n </div>\n </div>\n <div class=\"row justify-content-center text-center\">\n <div class=\"col-12 col-md-11 px-3\">\n <div class=\"wrapper mb-0\">\n <div class=\"youtube mb-4 bg-transparent p-0 video-modal-popup\" data-toggle=\"modal\"\n data-target=\"#video-modal\" data-id=\"gZIux6vkz6w\" data-title=\"CryptoFinallyExplained\">\n <div class=\"video-gradient-top\"></div>\n <p class=\"text-left dyk-video-title\">What is Yield Farming in Crypto? (Animated Explanation)</p>\n <img src=https://www.bitdegree.org/"https://i.ytimg.com/vi/gZIux6vkz6w/hq720.jpg/"/n alt=\"What is Yield Farming in Crypto? 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The rewards are passive, since you don’t need to actively participate in said processes, all the time.</p>\n<p>In this context, “farming” simply means “<strong>continuous acquisition</strong>”. So, “yield farming” is simply a method of receiving passive profits (in the form of some asset) in a recurring manner. In principle, that’s pretty simple!</p>\n<p>When it comes to crypto, yield farming isn’t all that different. You invest some cryptocurrency into a project, and then start receiving passive periodic gains - in other words, it’s a way to make a passive income!</p>\n<p>Well, “invest” isn’t even necessarily the right term to use here, really. Rather, you would “lock” your crypto for some period of time. Allow me to illustrate with an example.</p>\n<p><img style=\"display: block; margin-left: auto; margin-right: auto;\" title=\"What is yield farming: Yield farming in crypto.\" src=https://www.bitdegree.org/"https://assets.bitdegree.org/crypto/storage/media/what-is-yield-farming-1.o.jpg/" alt=\"What is yield farming: Yield farming in crypto.\" width=\"1000\" height=\"654\" /></p>\n<p>Imagine that you have a bag of 10 candies. One day, your friend comes up to you, and makes you an offer - if you give him the bag for a week, he’ll bring you back 12 candies.</p>\n<p>Now, your friend WILL use the candies in your bag, in order to trade them with other people. However, by the end of the week, no matter what happens, you will still get 12 candies back.</p>\n<p>Do you really care that your friend will use the candies throughout the week? Does that matter at all? Not really - all that matters is that <strong>you’ll get all of your candies back</strong>, and more!</p>\n<p>This is, essentially, how yield farming works in crypto, too. Naturally, though, there are different types of yield farming that you could participate in! So, let’s check each of these types out, and try to figure out which is the most worthwhile, shall we?</p>\n<h2>Crypto Lending and Borrowing</h2>\n<p>The very first form of yield farming that you’ll likely come across is cryptocurrency lending and borrowing. This concept has become very popular throughout the last year or two!</p>\n<p>There are multiple decentralized finance projects that allow crypto fans to both borrow cryptocurrencies, as well as lend them - platforms such as <strong>AAVE,</strong> which are a great example of this.</p>\n<p>The most common way to participate in yield farming with such projects is to lend your crypto. Let’s say, you have 1 <a href=https://www.bitdegree.org/"/crypto/buy-bitcoin-btc/">Bitcoin, and aren’t planning on selling or trading it anytime soon.</p>\n<p>You would go to a platform such as AAVE, and lend that Bitcoin to someone else. Don’t worry, since the entire process is automated, and happens via special pools - there are minimal risks involved. If you’re not familiar with liquidity pools, though, I highly encourage you to read the section on the topic, in order to get a better understanding of the concept.</p>\n<p>Now, depending on a few different factors, you could expect to receive an <strong>APR (Annual Percentage Rate)</strong> of up to and over 34%. In other words, in a year, you would end up with 0,34 BTC more - that’s a huge number!</p>\n<p>To put it into context, with traditional banking institutions, your APR won’t really go over 1%. Well, you can probably see why crypto yield farming is as hot of a topic as it is!</p>\n<p><img style=\"display: block; margin-left: auto; margin-right: auto;\" title=\"What is yield farming: Lending.\" src=https://www.bitdegree.org/"https://assets.bitdegree.org/crypto/storage/media/what-is-yield-farming-2-62740da312491.o.jpg/" alt=\"What is yield farming: Lending.\" width=\"1000\" height=\"752\" /></p>\n<p>Another awesome feature of cryptocurrency lending is that, in most cases, you are able to withdraw your money at any point in time. So, if you DO end up needing that 1 Bitcoin, you can just take it out, with no strings attached.</p>\n<p>Next up, borrowing. This one’s a bit tricky, I’ll admit, since it’s one of the <strong>more-unique forms</strong> of yield farming.</p>\n<p>Imagine that you have a very old and valuable painting. You love that painting, spent a lot of time admiring it, and thus, don’t want to sell it! However, you’re in a bit of a pickle - you really need some money.</p>\n<p>What you could do is borrow money, while placing your painting as collateral for the loan. Once you pay the loan (+interest) back, you will get your painting back, too. Now, since the painting is so old and valuable, its price on the market will increase during that period of the loan.</p>\n<p>This is the general view of how yield farming works when you borrow cryptocurrencies. If you believe that Bitcoin is an awesome crypto, and it will rise in price, you could <strong>use it as collateral</strong> for your loan - then, you would have some money to work with, while also having BTC locked in as collateral, with the hopes that, once you repay your loan, that Bitcoin will be worth more than when you initially had it!</p>\n<p>Now, there is one more awesome method of how you could participate in yield farming while borrowing and lending your cryptocurrencies. However, it’s a bit more complex, so we’ll leave it for the end of the section, as a bonus - make sure to read it till the end!</p>\n<h2>Providing Liquidity</h2>\n<p>Moving on, the second big form of yield farming is becoming a liquidity provider. It sounds fancy, but the core idea behind this is very simple - in order to understand it as best as possible, however, you should really go and read the section on <a href=https://www.bitdegree.org/"/crypto/learn/what-is-liquidity-pool-in-crypto/">liquidity pools</strong></a> that I’ve mentioned earlier!</p>\n<p><strong>Liquidity providers</strong> are people that provide their money to decentralized cryptocurrency exchanges, and receive passive returns for doing so. Let’s say that you have a $1000 laying around, and want to make it “work for you”, so to speak. Well, to start off, you would first convert that money to two cryptocurrencies - let’s say, Ethereum and AAVE.</p>\n<p>Then, you would take your ETH and AAVE, and provide it to a decentralized exchange, such as Uniswap. People would then use your <a href=https://www.bitdegree.org/"/crypto/buy-ethereum-eth/">Ethereum and AAVE in order to swap from one cryptocurrency to another. Each of these swaps have fees!</p>\n<p>Now, the <strong>fees</strong> are collected by Uniswap, and distributed to the liquidity providers as payment for their liquidity. A very simple, yet super-effective model!</p>\n<p><img style=\"display: block; margin-left: auto; margin-right: auto;\" title=\"What is yield farming: Providing liquidity.\" src=https://www.bitdegree.org/"https://assets.bitdegree.org/crypto/storage/media/what-is-yield-farming-3.o.jpg/" alt=\"What is yield farming: Providing liquidity.\" width=\"1000\" height=\"522\" /></p>\n<p>Your actual passive gains will depend on a few different factors. First of all, the amount that you provide as liquidity, and how many other liquidity providers are in the same pool. If the ETH-AAVE pool is huge, and there are thousands of others providing liquidity, you’ll probably get a smaller return!</p>\n<p>However, if you provide the pool with a hefty sum of tokens, your returns will be much bigger, as well.</p>\n<p>Another thing to look out for are the fees that the decentralized exchange imposes. Depending on these fees, your reward will vary, as well! To this day, however, Uniswap remains the most popular decentralized exchange when it comes to <strong>providing liquidity</strong> and earning passive interest.</p>\n<h2>Staking</h2>\n<p>Continuing on with the section, the third method of how you can participate in yield farming is one that’s familiar to many cryptocurrency enthusiasts - <a href=https://www.bitdegree.org/"/crypto/learn/crypto-terms/what-is-staking/">staking.
/n
At first glance, staking can appear much the same as providing liquidity - you have some crypto coins or tokens, and provide them to a specific platform, in order to earn passive returns. I have to admit, going into the topic in-depth, things aren’t that simple - do check out the section on <a href=https://www.bitdegree.org/"/crypto/learn/what-is-staking-in-crypto/">staking, as well as the differences between <a href=https://www.bitdegree.org/"/crypto/learn/coin-vs-token/">coins and tokens</strong></a> if you’d like to learn more.</p>\n<p>For the sake of keeping this section about yield farming, though, let’s just say that staking is when you <strong>lock up your tokens</strong> in the network, in order for them to confirm other people’s transactions. Only specific coins can be staked - those that are built on the <a href=https://www.bitdegree.org/"/crypto/learn/crypto-terms/what-is-proof-of-stake-pos/">Proof-of-Stake consensus model!</p>\n<p><img style=\"display: block; margin-left: auto; margin-right: auto;\" title=\"What is yield farming: Proof-of-Stake.\" src=https://www.bitdegree.org/"https://assets.bitdegree.org/crypto/storage/media/what-is-yield-farming-4.o.jpg/" alt=\"What is yield farming: Proof-of-Stake.\" width=\"1000\" height=\"764\" /></p>\n<p>The simplest example of staking would be that of the Cardano project, and its native coin called ADA. You can purchase ADA on most top-rated cryptocurrency exchanges on the market, such as Binance or Coinbase. After you have your ADA coins, you would then need to find a staking pool - the simplest way to do this is to transfer your ADA into the Yoroi wallet - it’s a browser extension-based wallet, and is the most popular place where people store and keep their ADA coins. Also, Yoroi has multiple pools available to be accessed from within the <a href=https://www.bitdegree.org/"https://www.bitdegree.org/crypto/best-cryptocurrency-wallet/">wallet!
/n
All that you need to do is choose the pool that you want, and delegate <strong>your ADA coins</strong> into it. As time goes on, your coins will start earning passive returns for you!</p>\n<p>Admittedly, this is a topic that deserves a separate section, of its own.</p>\n<p><img style=\"display: block; margin-left: auto; margin-right: auto;\" title=\"What is yield farming: Staking = providing liquidity.\" src=https://www.bitdegree.org/"https://assets.bitdegree.org/crypto/storage/media/what-is-yield-farming-5.o.jpg/" alt=\"What is yield farming: Staking = providing liquidity.\" width=\"1000\" height=\"319\" /></p>\n<p>Another way how you can stake coins, and thus, farm yield, is on <a href=https://www.bitdegree.org/"https://www.bitdegree.org/crypto/best-cryptocurrency-exchange/">cryptocurrency exchanges</strong></a> themselves. Some of the most popular exchange platforms are beginning to offer their users staking functionality - you could purchase coins, and then simply stake them from within your exchange-based cryptocurrency wallet - there’s usually just one button to press, and that’s it!</p>\n<p><img style=\"display: block; margin-left: auto; margin-right: auto;\" title=\"What is yield farming: Staking coins.\" src=https://www.bitdegree.org/"https://assets.bitdegree.org/crypto/storage/media/what-is-yield-farming-6.o.jpg/" alt=\"What is yield farming: Staking coins.\" width=\"1000\" height=\"518\" /></p>\n<p>In most cases, your yield rewards will be the same tokens that you stake, or the so-called “LP tokens”, otherwise known as liquidity provider tokens. You will then be able to trade these LP tokens to another cryptocurrency, such as Ethereum.</p>\n<h2>Redistribution Fees</h2>\n<p>The last big method of how you can participate in yield farming is by holding cryptocurrencies that have <strong>redistribution fees</strong>.</p>\n<p>Sounds fancy? Well, it’s super-simple, really!</p>\n<p>Some cryptocurrencies have what are called “redistribution fees”. This means that, whenever you trade this crypto, a part of the fees that you pay for the trade will be distributed to other holders of this cryptocurrency.</p>\n<p>Probably the best-known example of this would be <strong>Safemoon</strong>. This is a very popular cryptocurrency that has redistribution fees, as well as token-<a href=https://www.bitdegree.org/"/crypto/learn/crypto-terms/what-is-burning/">burning mechanics.</p>\n<p>Token burning sounds pretty fancy, but it really is simple. As you transact with a cryptocurrency, you pay certain fees for your transactions, in the form of those same tokens - so, let’s say, if you want to send 10 Safemoon to your friend, that will cost you 1 Safemoon token, as a transaction fee.</p>\n<p><img style=\"display: block; margin-left: auto; margin-right: auto;\" title=\"What is yield farming: Safemoon example.\" src=https://www.bitdegree.org/"https://assets.bitdegree.org/crypto/storage/media/what-is-yield-farming-7.o.jpg/" alt=\"What is yield farming: Safemoon example.\" width=\"1000\" height=\"958\" /></p>\n<p>Some of those fees will be redistributed to token holders - say, they would share 0,5 of a Safemoon token. The other 0,5 Safemoon would be sent to an <strong>inactive, inaccessible wallet</strong>. This is what is called “token burning” - tokens in this wallet would be lost forever. This way, the token battles inflation, and still rewards holders!</p>\n<p>Now, obviously, there are various technicalities to be aware of, when it comes to this type of yield farming. The token may sway in price heavily, and you would need to have A LOT of tokens in order to receive any notable yield gains.</p>\n<h2>Leveraged Lending</h2>\n<p>So, with the four big, main yield farming methods out of the way, I’d also like to tell you about a bonus method. It’s called “leveraged lending” - I left it as a bonus because it’s a bit trickier than the other yield farming tactics we’ve discussed in this section.</p>\n<p>Imagine that you have $100 in ETH. You decide to lend the ETH, and borrow some <strong>DOGE coins</strong>, by putting your ETH up as collateral. Since your collateral will always need to be bigger than your loan, you receive $70 worth of Dogecoin in return.</p>\n<p>Now, what you would do is go to a cryptocurrency exchange, and trade in your Dogecoins for Ethereum. You now have ETH again! So, you take it back to the lending platform, put in your new ETH coins, and borrow some more Dogecoin - and repeat the process!</p>\n<p>Since your collateral will always be higher than your loan, this does have an endpoint. However, by the end, you’ll have much more ETH in the lending platform than you did at the beginning.</p>\n<p>This isn’t a very simple process to set up, since it requires knowledge of APRs, different lending and borrowing platforms, and great timing. Also, the prices of cryptocurrencies these days are <strong>rather volatile</strong>, and you might end up liquidating your positions, if the price of ETH drops too much. However, with a bit of practice, this can be a pretty interesting yield farming strategy!</p>\n<p>So, to conclude the section, I’d like to say that, when it comes to yield farming, there are multiple methods that you could employ, with varying degrees of risk and reward. In short, though, you should focus on the <strong>top-rated projects,</strong> and cryptocurrencies that have historically shown signs of resistance against large price swings and general market volatility.</p>","preview_url":"https://www.bitdegree.org/crypto/learn/what-is-yield-farming-in-crypto","youtube_video":{"id":17,"channel_id":1,"sort":45,"video_title":"What is Yield Farming in Crypto? (Animated Explanation)","description":"What is yield farming in crypto?\n\nYield farming allows you to use cryptocurrencies in order to earn a passive income over a period of time, without selling or trading your actual cryptos. \n\nThere are multiple methods of how you can participate in yield farming, all coming with varying degrees of risk and reward. In this video, I will tell you about the main methods, and explain how you can start farming crypto yield today!\n\nHave you ever participated in cryptocurrency yield farming activities? Share your experiences in the comment section below!\n\nVideo Time Table:\n\n0:00 Introduction to What is Yield Farming in Crypto\n0:41 What is Yield Farming?\n2:09 Crypto Lending & Borrowing\n4:30 Providing Liquidity\n5:57 Staking\n7:54 Redistribution Fees\n9:11 Leveraged Lending\n10:15 Wrap-up: What is Yield Farming in Crypto?\n\nGet Quick Crypto Tips on Twitter - Follow:\nhttps://twitter.com/crypto_xplained\n\n#WhatisYieldFarming #YieldFarmingCrypto #CryptoYieldFarming #YieldFarmingExplained #CryptoFarming","video_id":"gZIux6vkz6w","duration":643,"view_count":757,"thumbnail_url":"https://i.ytimg.com/vi/gZIux6vkz6w/hq720.jpg","thumbnail_width":1280,"thumbnail_height":720,"published_at":"2022-03-22 16:17:03","created_at":"2022-03-22T23:00:02.000000Z","updated_at":"2023-05-21T23:00:04.000000Z","channel":{"id":1,"title":"CryptoFinallyExplained","channel_id":"UCOryUY0yxC08eJtK23mNgiA","main_playlist_id":"UUOryUY0yxC08eJtK23mNgiA"}}},"prevSection":{"id":9,"featured_image_id":6488,"original_id":null,"youtube_video_id":3,"author_id":42,"translator_id":null,"chapter_id":6,"title":"What is a Liquidity Pool and How Does It Work?","slug":"what-is-liquidity-pool-in-crypto","definition":"Did you know that liquidity pools allow your money to work for you?","status":"published","content":"<p>In this section, we’re going to be answering the question of <strong>what is a Liquidity Pool in Crypto.</strong></p>\n<p>Imagine that you have $100 of spare money - money that you don’t need at this point in time, and can use at your leisure. Now, one day you are approached by your friend, who offers you a deal - both of you throw your $100 bills into a pot, invite a few other friends to do the same, and then allow other people to use the money from that pot. In turn, you will earn <strong>passive interest</strong> over time.</p>\n<p>In essence, this is a very broad explanation of how a liquidity pool works. In this section, we’ll answer questions such as what a liquidity pool is, how it works, and why such a concept is useful, in the first place.</p>\n<p><em>Let’s not waste any time and get right to it!</em></p>\n<h2>What is a Liquidity Pool?</h2>\n<p>Firstly, let’s establish what exactly is a liquidity pool. There are two ways how you can look at it - as an <strong>investor</strong>, and as someone who will <strong>actually use the pool.</strong></p>\n<p><strong><img title=\"\" src=https://www.bitdegree.org/"https://assets.bitdegree.org/crypto/storage/media/what-is-liquidity-pool-1.o.jpg/" alt=\"What is liquidity pool in crypto: Liquidity provider.\" width=\"800\" height=\"478\" /></strong></p>\n<p>First, let’s discuss the investor’s point of view.</p>\n<p>A liquidity pool is a place where you can lock up your money or a specific asset, for a set amount of time. If you do so, you’ll be called -<a href=https://www.bitdegree.org/"/crypto/learn/crypto-terms/what-is-liquidity-provider/"> </a><strong><a href=https://www.bitdegree.org/"/crypto/learn/crypto-terms/what-is-liquidity-provider/">a liquidity provider</a>.</strong> Referencing the example given at the beginning of this section, imagine that you and your friend decide to throw your $100 bills into a pot for a week - after a week, you need that money for a new keyboard! Well, liquidity pools allow you to take your money out, usually without any problems, and at any point in time.</p>\n<p>In the upcoming week, you are free to go on with your life - there is nothing else that you need to do in regards to that pot. Liquidity pools allow your money to work for you - after a week, you might come to find that your $100 has now turned into $110!</p>\n<p>Now, obviously, this is just an example, and the rate at which you will earn the passive interest will vary from pool to pool, but you get a general idea, nonetheless. Think about it this way - some pots will be old and barely usable, while others - embedded with fancy jewels and made out of gold. Thus, your earnings will differ, accordingly!</p>\n<p>Now, you do need to know that you can provide<strong> other crypto assets</strong> to the liquidity pool, and not only <strong><a href=https://www.bitdegree.org/"/crypto/learn/crypto-terms/what-is-fiat/">fiat money</a>.</strong> It all depends on the pool. For example, some liquidity pools might allow you to earn interest on <a href=https://www.bitdegree.org/"https://www.bitdegree.org/crypto/buy-bitcoin-btc/">Bitcoin, <a href=https://www.bitdegree.org/"https://www.bitdegree.org/crypto/buy-ethereum-eth/">Ethereum, and other super-popular cryptocurrencies!</p>\n<p>From a liquidity provider's point of view, that’s the general idea of how a liquidity pool works. It’s rather simple, on the surface level - you put money in, hoping that, in some time, you’ll take out a bit more.</p>\n<p>Moving on, in order to understand the use cases of liquidity pools from the user side of the table, we need to take a look at how these pools work, in the first place.</p>\n<h2>How Do Liquidity Pools Work?</h2>\n<p>Imagine that it’s a beautiful summer day outside, and you’re sitting in your room, all jolly and relaxed. Suddenly, you remember that you’re in need of a new laptop - your old computer is laggy and worn down, and takes about 26,5 years to turn on. Being in a great mood, you decide that it’s time to order a new laptop.</p>\n<p>You find one that you like online and go through the checkout process. Here, you need to put in your personal information, name and surname, address, and your bank information. This is all fine and dandy, however, what if you DON’T want to do that?</p>\n<p>Specifically, what if you DON’T want the shop to know all of your information? Well, what if there was a way to purchase the computer, without actually providing any personal details about yourself - simply sending the money, and receiving the new laptop at a specified location, without involving any other third-party human beings into the process?</p>\n<p>Well, in a very rough way, this is how DEXes - <a href=https://www.bitdegree.org/"/crypto/learn/crypto-terms/what-is-decentralized-exchange-dex/">decentralized cryptocurrency exchanges</strong></a> - work. These exchange platforms allow users to trade different crypto coins and tokens <strong>without having to provide personal information</strong> to any specific, centralized institution.</p>\n<p>Now, I’ve mentioned <strong>coins</strong> and <strong>tokens</strong> - if you’d like to learn more about the differences between the two, don’t forget to check out the section <strong>\"<a href=https://www.bitdegree.org/"/crypto/learn/coin-vs-token/">Coin VS Token</a>\".</strong></p>\n<p>In order for decentralized exchanges to function properly in an automated manner, they need to have some sort of an asset pool. It’s like a car and fuel - while the car might be awesome, if it has no fuel, it’s useless. This is where liquidity pools come in.</p>\n<p>Namely, liquidity pools allow decentralized exchanges to function, in the first place. When you come to trade on a DEX, and want to, say, sell your tokens, liquidity pools allow you to do so - they hold some of those tokens inside of themselves, and pay out the crypto that you want for the tokens.</p>\n<p>To understand the process clearly, you should know that, fundamentally, trades were based on so-called <a href=https://www.bitdegree.org/"/crypto/learn/crypto-terms/what-is-order-book/">Order Books</strong></a>. In short, the idea of an Order Book is to match a buyer with a seller, and finally close their deal.</p>\n<p><img style=\"display: block; margin-left: auto; margin-right: auto;\" title=\"\" src=https://www.bitdegree.org/"https://assets.bitdegree.org/crypto/storage/media/what-is-liquidity-pool-2.o.jpg/" alt=\"What is liquidity pool in crypto: Order Book.\" width=\"800\" height=\"696\" /></p>\n<p>With the Order Book, sellers will set <strong>the minimum price </strong>of the assets they want to sell, and buyers will set <strong>the</strong> <strong>maximum price</strong> they are willing to pay for such assets. If the system matches the seller and buyer, both with the same set price for the same item, it finalizes the deal. This is a classic way of functioning for any marketplace.</p>\n<p>With Liquidity Pools, it's a different story, and Order Booking is not needed here anymore! A simple illustration of the same trade process with a Liquidity pool would look like this: </p>\n<p>First of all, as I mentioned earlier, the liquidity pool is filled with a bunch of funds provided by liquidity providers. When you’re buying or selling your desired coin on a liquidity pool, there is no seller or buyer on the other side, as we tend to have them normally with the Order Book. Instead, you always trade with the pool itself. All your and pool activities are governed by the <strong>automated algorithm in a <a href=https://www.bitdegree.org/"/crypto/learn/crypto-terms/what-is-smart-contract/">smart contract</a>.</strong></p>\n<p><strong><img style=\"display: block; margin-left: auto; margin-right: auto;\" title=\"\" src=https://www.bitdegree.org/"https://assets.bitdegree.org/crypto/storage/media/what-is-liquidity-pool-3.o.jpg/" alt=\"What is liquidity pool in crypto: How do liquidity pools work?\" width=\"800\" height=\"732\" /></strong></p>\n<p>Prices of our trades are also managed by this algorithm, based on the current and historical trades that happened in that pool. So, no humans are needed on the other side, to make the trade happen, because everything that happens is between you and a programmed algorithm that is launched on a blockchain, and can’t be changed.</p>\n<p>In short, by default, a pool is filled with<strong> a 50/50 ratio of 2 coins.</strong> Let’s say, it’s 50% <a href=https://www.bitdegree.org/"https://www.bitdegree.org/crypto/buy-bitcoin-btc/">Bitcoin, and 50% <a href=https://www.bitdegree.org/"https://www.bitdegree.org/crypto/buy-ethereum-eth/">Ethereum. After you start buying Bitcoins with your Ethereum in that pool, the pool starts losing its Bitcoins and obtaining more and more Ethereum coins from you.</p>\n<p>In this case, the algorithm of the pool will incrementally raise the price of the Bitcoin and lower the price of Ethereum, because it clearly sees the demand of Bitcoin and the supply of Ethereum. This is the automated pool reaction to the market needs, everything is self-regulated.</p>\n<p>Also, this illustration answers the question why liquidity pools are looking for more and more liquidity investors. And the answer is - the bigger the pool and sum of assets in it, the less it’s sensitive to massive buy and sell trades, and the price algorithm of the assets stays less sensitive to the market itself, because, with each trade, the pool will obtain or lose just a little amount of assets, when compared to the whole liquidity pool size.</p>\n<p>Now, allow me to be clear - the processes behind liquidity pools are <strong>far more complicated than that. </strong>There are a ton of different features related to these projects, and each pool needs to be developed and programmed using smart contracts and advanced coding logic.</p>\n<p>For your average person, though, all of that is trivial. You aren’t going to need to know the intricacies of liquidity pools in order to use them. Suffice to say that liquidity pools hold two or more assets (cryptocurrencies, USD, and so on) inside of them, and allow people to trade on decentralized exchange platforms.</p>\n<p>In turn, while individuals use the pools for their trades, investors will receive interest on their investments, over time. <em>Simple!</em></p>\n<h2>Why are Liquidity Pools Useful?</h2>\n<p>Now that you have a better idea of what liquidity pools are and how they work, let’s explore the concept of why anyone would want to use these pools in the first place.</p>\n<p><img style=\"display: block; margin-left: auto; margin-right: auto;\" title=\"\" src=https://www.bitdegree.org/"https://assets.bitdegree.org/crypto/storage/media/what-is-liquidity-pool-4.o.jpg/" alt=\"What is liquidity pool in crypto: Why are liquidity pools useful?\" width=\"800\" height=\"314\" /></p>\n<p>We’ve already covered the very general ideas of why someone might want to use liquidity pools - investors want to <strong>earn a premium,</strong> while traders are able to <strong>trade the cryptocurrencies</strong> that they want, on decentralized exchanges, thanks to those same liquidity pools. However, the reasoning goes much deeper, too.</p>\n<p>Imagine that you’re trading on a centralized, well-known cryptocurrency exchange. Suddenly, the price of Bitcoin drops by 40%, out of the blue. What do you think happens next?</p>\n<p>If you said “panic”, you’re definitely correct.</p>\n<p><img style=\"display: block; margin-left: auto; margin-right: auto;\" title=\"\" src=https://www.bitdegree.org/"https://assets.bitdegree.org/crypto/storage/media/what-is-liquidity-pool-5.o.jpg/" alt=\"What is liquidity pool in crypto: Trading on a centralized crypto exchange.\" width=\"801\" height=\"297\" /></p>\n<p>Fearing further price plunges, thousands of traders and their pets rush to the exchange, in order to sell their BTC. While all of this is happening, the CEO of the exchange sees that the situation is dire - they are running out of fiat money, and their servers are crashing.</p>\n<p>The CEO decides to freeze the transactions - in other words, you are no longer able to sell your BTC on the exchange. Just to be clear, the managing staff of a <a href=https://www.bitdegree.org/"/crypto/learn/crypto-terms/what-is-centralized-exchange-cex/">centralized exchange</strong></a> is always prepared to pull the kill-switch, and to turn off our trading party if a situation starts moving away from their interests.</p>\n<p>THIS is exactly why decentralized exchanges are popular and useful. <strong>No one person can dictate what happens with a DEX</strong> simply because he got out of bed on the wrong foot that morning. And liquidity pools allow these DEXs to remain decentralized, in the first place!</p>\n<p>On top of that, if the aforementioned CEO freezes the operations of their exchange, as discussed earlier, this will impact the price further - people will start panicking even more! On a decentralized exchange, liquidity pools are the ones that dictate the price of an asset - they are not impacted by bad mood or weather<em>. </em></p>\n<p>Sure, the price will follow the market, but it will be <strong>less prone to various forms of manipulation. </strong>Once again, this is thanks to the logic behind liquidity pool development.</p>\n<p>Also let’s not forget about market-making mechanisms on some centralized exchanges, where sneaky exchange owners deal with specific coin creators so that the exchange will move their coins by buying and selling them hundreds of times, without any fee, to create a volume and some sort of activity of the so-called “<a href=https://www.bitdegree.org/"/crypto/learn/crypto-terms/what-is-shitcoin/">shitcoin”, to make it look like an active project with thousands of active transactions, buyers and sellers.</p>\n<p><img style=\"display: block; margin-left: auto; margin-right: auto;\" title=\"\" src=https://www.bitdegree.org/"https://assets.bitdegree.org/crypto/storage/media/what-is-liquidity-pool-6.o.jpg/" alt=\"What is liquidity pool in crypto: Market-making mechanism.\" width=\"801\" height=\"196\" /></p>\n<p>By doing so, they try to imitate activity and look prettier to potential investors on the market. And this is one of the darkest things on centralized exchanges, especially with new, less-known altcoins.</p>\n<p>Another use for liquidity pools among traders is “<a href=https://www.bitdegree.org/"/crypto/learn/crypto-terms/what-is-arbitrage/">arbitrage trading</strong></a>”. A very fancy term, sure, but the concept is actually very simple! Traders try to search for many liquidity pools with the best prices of an asset lying within, and then buy that asset, so that they could trade it on centralized or even other decentralized exchanges, and make a profit with a difference in doing so.</p>\n<p>Let's imagine a trader finds the DEX that currently trades some coin or token for $50 per coin. After buying these tokens, he goes to a different exchange with a higher bid price for the same coin and sells it there for $51 per coin. By doing so, his profit is $1 per coin, and this is huge!</p>\n<p><img style=\"display: block; margin-left: auto; margin-right: auto;\" title=\"\" src=https://www.bitdegree.org/"https://assets.bitdegree.org/crypto/storage/media/what-is-liquidity-pool-7.o.jpg/" alt=\"What is liquidity pool in crypto: Arbitrage trading.\" width=\"800\" height=\"469\" /></p>\n<p>Arbitrage trading requires a lot of experience and discipline, but it’s one of the more common uses for liquidity pools, nonetheless. It’s made possible due to the <strong>common asset price differences</strong> between centralized exchanges and liquidity pools.</p>\n<p>All in all, there’s a lot more when it comes to liquidity pools, but the information discussed in this section should serve as a great starting point for beginners.</p>","meta_title":"What is a Liquidity Pool in Crypto? Its Benefits and Usage","meta_description":"If you're trying to figure out what is a liquidity pool in the crypto world, you'll find everything you need to know right here!","meta_keywords":"what is a liquidity pool, what is liquidity pool in cryptocurrency, what is crypto liquidity pool, what is uniswap liquidity pool, uniswap liquidity pool, uniswap liquidity pool returns","order":9,"language":"en","created_at":"2022-05-03T06:02:27.000000Z","updated_at":"2023-03-10T08:17:31.000000Z","modified_content":"<p>In this section, we’re going to be answering the question of <strong>what is a Liquidity Pool in Crypto.</strong></p>\n<p>Imagine that you have $100 of spare money - money that you don’t need at this point in time, and can use at your leisure. Now, one day you are approached by your friend, who offers you a deal - both of you throw your $100 bills into a pot, invite a few other friends to do the same, and then allow other people to use the money from that pot. In turn, you will earn <strong>passive interest</strong> over time.</p>\n<p>In essence, this is a very broad explanation of how a liquidity pool works. In this section, we’ll answer questions such as what a liquidity pool is, how it works, and why such a concept is useful, in the first place.</p>\n<p><em>Let’s not waste any time and get right to it!</em></p>\n<div class=\"container\">\n <div class=\"row justify-content-center\">\n <div class=\"col-md-10 comparison-suggestion pb-3 mb-4\">\n <div class=\"d-flex flex-row\">\n <div class=\"text-center\">\n <div class=\"img-block-yt\">\n <img src=https://www.bitdegree.org/"https://assets.bitdegree.org/crypto/assets/images/compare-crypto-exchanges.gif/"/n alt=\"What is a Liquidity Pool in Crypto? (Animated)\"\n title=\"What is a Liquidity Pool in Crypto? (Animated)\" class=\"border-0\">\n <p>Video Explainer</p>\n </div>\n </div>\n <div class=\"col-xs-10 col-sm-10 col-md-10 text-left py-3 yt-info\">\n <h4 class=\"mb-1\">Video Explainer: What is a Liquidity Pool and How Does It Work?</h4>\n <p class=\"py-1 mb-0 youtube-video-subtitle\">Reading is not your thing? Watch the \"What is a Liquidity Pool and How Does It Work?\" video explainer</p>\n </div>\n </div>\n <div class=\"row justify-content-center text-center\">\n <div class=\"col-12 col-md-11 px-3\">\n <div class=\"wrapper mb-0\">\n <div class=\"youtube mb-4 bg-transparent p-0 video-modal-popup\" data-toggle=\"modal\"\n data-target=\"#video-modal\" data-id=\"X8J3qSI3avg\" data-title=\"CryptoFinallyExplained\">\n <div class=\"video-gradient-top\"></div>\n <p class=\"text-left dyk-video-title\">What is a Liquidity Pool in Crypto? (Animated)</p>\n <img src=https://www.bitdegree.org/"https://i.ytimg.com/vi/X8J3qSI3avg/hq720.jpg/"/n alt=\"What is a Liquidity Pool in Crypto? (Animated)\"\n title=\"What is a Liquidity Pool in Crypto? (Animated)\"\n class=\"p-0\">\n <img class=\"play-button\" data-target=\"#video-modal\"\n src=https://www.bitdegree.org/"https://assets.bitdegree.org/crypto/assets/video-button.png/"/n alt=\"What is a Liquidity Pool in Crypto? (Animated)\">\n </div>\n </div>\n </div>\n </div>\n <div class=\"row justify-content-center text-center\">\n <div>\n <a href=https://www.bitdegree.org/"https://www.youtube.com/c/CryptoFinallyExplained?sub_confirmation=1\%22\n class=\"btn yt-promo mb-2\" target=\"_blank\" rel=\"nofollow noopener\">\n <div class=\"row justify-content-center align-items-center mx-0 text-center\">\n <div class=\"col-4 col-md-4\">\n <i class=\"fab fa-youtube yt-dyk-btn\"></i>\n </div>\n <div class=\"col-8 col-md-8 text-center yt-promo-text\">\n <h4 class=\"m-0 text-white\">SUBSCRIBE</h4>\n <span>ON YOUTUBE</span>\n </div>\n </div>\n </a>\n </div>\n </div>\n </div>\n </div>\n</div>\n<div class=\"modal fade\" id=\"video-modal\" tabindex=\"-1\" role=\"dialog\" aria-labelledby=\"X8J3qSI3avg\">\n <div class=\"modal-dialog modal-dialog-centered modal-lg\" role=\"document\">\n <div class=\"modal-content\">\n <div class=\"modal-body p-0\">\n <button type=\"button\" class=\"video-modal-close close\" data-dismiss=\"modal\" aria-label=\"Close\">\n <i aria-hidden=\"true\" class=\"fas fa-times\"></i>\n </button>\n <div id=\"iframe\"></div>\n </div>\n <a class=\"text-decoration-none\"\n href=https://www.bitdegree.org/"https://www.youtube.com/c/CryptoFinallyExplained?sub_confirmation=1\%22\n rel=\"nofollow noopener\" target=\"_blank\">\n <div class=\"modal-footer p-0 d-block bg-white\">\n <div class=\"row justify-content-center m-0\">\n <div class=\"col-3 col-md-4 col-lg-2 p-0\">\n <img class=\"w-100 h-100\" src=https://www.bitdegree.org/"https://assets.bitdegree.org/crypto/assets/crypto-subscribe.jpg/" alt=\"Subscribe\">\n </div>\n <div class=\"col-9 col-md-8 col-lg-2 px-0 d-flex\">\n <div class=\"modal-subscribe w-100\">\n <p class=\"m-0 mt-1 mr-3\">SUBSCRIBE<br>\n <span class=\"m-0\">ON YOUTUBE</span>\n </p>\n </div>\n </div>\n <div class=\"col-12 col-md-12 col-lg-8 p-0 text-center d-flex justify-content-center align-items-center\">\n <div class=\"modal-subscribe-text\">\n <h4 class=\"m-0\">Understand crypto with ease</h4>\n <span>New explainer videos every week!</span>\n </div>\n </div>\n </div>\n </div>\n </a>\n </div>\n </div>\n</div>\n<h2>What is a Liquidity Pool?</h2>\n<p>Firstly, let’s establish what exactly is a liquidity pool. There are two ways how you can look at it - as an <strong>investor</strong>, and as someone who will <strong>actually use the pool.</strong></p>\n<p><strong><img title=\"\" src=https://www.bitdegree.org/"https://assets.bitdegree.org/crypto/storage/media/what-is-liquidity-pool-1.o.jpg/" alt=\"What is liquidity pool in crypto: Liquidity provider.\" width=\"800\" height=\"478\" /></strong></p>\n<p>First, let’s discuss the investor’s point of view.</p>\n<p>A liquidity pool is a place where you can lock up your money or a specific asset, for a set amount of time. If you do so, you’ll be called -<a href=https://www.bitdegree.org/"/crypto/learn/crypto-terms/what-is-liquidity-provider/"> </a><strong><a href=https://www.bitdegree.org/"/crypto/learn/crypto-terms/what-is-liquidity-provider/">a liquidity provider</a>.</strong> Referencing the example given at the beginning of this section, imagine that you and your friend decide to throw your $100 bills into a pot for a week - after a week, you need that money for a new keyboard! Well, liquidity pools allow you to take your money out, usually without any problems, and at any point in time.</p>\n<p>In the upcoming week, you are free to go on with your life - there is nothing else that you need to do in regards to that pot. Liquidity pools allow your money to work for you - after a week, you might come to find that your $100 has now turned into $110!</p>\n<p>Now, obviously, this is just an example, and the rate at which you will earn the passive interest will vary from pool to pool, but you get a general idea, nonetheless. Think about it this way - some pots will be old and barely usable, while others - embedded with fancy jewels and made out of gold. Thus, your earnings will differ, accordingly!</p>\n<p>Now, you do need to know that you can provide<strong> other crypto assets</strong> to the liquidity pool, and not only <strong><a href=https://www.bitdegree.org/"/crypto/learn/crypto-terms/what-is-fiat/">fiat money</a>.</strong> It all depends on the pool. For example, some liquidity pools might allow you to earn interest on <a href=https://www.bitdegree.org/"https://www.bitdegree.org/crypto/buy-bitcoin-btc/">Bitcoin, <a href=https://www.bitdegree.org/"https://www.bitdegree.org/crypto/buy-ethereum-eth/">Ethereum, and other super-popular cryptocurrencies!</p>\n<p>From a liquidity provider's point of view, that’s the general idea of how a liquidity pool works. It’s rather simple, on the surface level - you put money in, hoping that, in some time, you’ll take out a bit more.</p>\n<p>Moving on, in order to understand the use cases of liquidity pools from the user side of the table, we need to take a look at how these pools work, in the first place.</p>\n<h2>How Do Liquidity Pools Work?</h2>\n<p>Imagine that it’s a beautiful summer day outside, and you’re sitting in your room, all jolly and relaxed. Suddenly, you remember that you’re in need of a new laptop - your old computer is laggy and worn down, and takes about 26,5 years to turn on. Being in a great mood, you decide that it’s time to order a new laptop.</p>\n<p>You find one that you like online and go through the checkout process. Here, you need to put in your personal information, name and surname, address, and your bank information. This is all fine and dandy, however, what if you DON’T want to do that?</p>\n<p>Specifically, what if you DON’T want the shop to know all of your information? Well, what if there was a way to purchase the computer, without actually providing any personal details about yourself - simply sending the money, and receiving the new laptop at a specified location, without involving any other third-party human beings into the process?</p>\n<p>Well, in a very rough way, this is how DEXes - <a href=https://www.bitdegree.org/"/crypto/learn/crypto-terms/what-is-decentralized-exchange-dex/">decentralized cryptocurrency exchanges</strong></a> - work. These exchange platforms allow users to trade different crypto coins and tokens <strong>without having to provide personal information</strong> to any specific, centralized institution.</p>\n<p>Now, I’ve mentioned <strong>coins</strong> and <strong>tokens</strong> - if you’d like to learn more about the differences between the two, don’t forget to check out the section <strong>\"<a href=https://www.bitdegree.org/"/crypto/learn/coin-vs-token/">Coin VS Token</a>\".</strong></p>\n<p>In order for decentralized exchanges to function properly in an automated manner, they need to have some sort of an asset pool. It’s like a car and fuel - while the car might be awesome, if it has no fuel, it’s useless. This is where liquidity pools come in.</p>\n<p>Namely, liquidity pools allow decentralized exchanges to function, in the first place. When you come to trade on a DEX, and want to, say, sell your tokens, liquidity pools allow you to do so - they hold some of those tokens inside of themselves, and pay out the crypto that you want for the tokens.</p>\n<p>To understand the process clearly, you should know that, fundamentally, trades were based on so-called <a href=https://www.bitdegree.org/"/crypto/learn/crypto-terms/what-is-order-book/">Order Books</strong></a>. In short, the idea of an Order Book is to match a buyer with a seller, and finally close their deal.</p>\n<p><img style=\"display: block; margin-left: auto; margin-right: auto;\" title=\"\" src=https://www.bitdegree.org/"https://assets.bitdegree.org/crypto/storage/media/what-is-liquidity-pool-2.o.jpg/" alt=\"What is liquidity pool in crypto: Order Book.\" width=\"800\" height=\"696\" /></p>\n<p>With the Order Book, sellers will set <strong>the minimum price </strong>of the assets they want to sell, and buyers will set <strong>the</strong> <strong>maximum price</strong> they are willing to pay for such assets. If the system matches the seller and buyer, both with the same set price for the same item, it finalizes the deal. This is a classic way of functioning for any marketplace.</p>\n<p>With Liquidity Pools, it's a different story, and Order Booking is not needed here anymore! A simple illustration of the same trade process with a Liquidity pool would look like this: </p>\n<p>First of all, as I mentioned earlier, the liquidity pool is filled with a bunch of funds provided by liquidity providers. When you’re buying or selling your desired coin on a liquidity pool, there is no seller or buyer on the other side, as we tend to have them normally with the Order Book. Instead, you always trade with the pool itself. All your and pool activities are governed by the <strong>automated algorithm in a <a href=https://www.bitdegree.org/"/crypto/learn/crypto-terms/what-is-smart-contract/">smart contract</a>.</strong></p>\n<p><strong><img style=\"display: block; margin-left: auto; margin-right: auto;\" title=\"\" src=https://www.bitdegree.org/"https://assets.bitdegree.org/crypto/storage/media/what-is-liquidity-pool-3.o.jpg/" alt=\"What is liquidity pool in crypto: How do liquidity pools work?\" width=\"800\" height=\"732\" /></strong></p>\n<p>Prices of our trades are also managed by this algorithm, based on the current and historical trades that happened in that pool. So, no humans are needed on the other side, to make the trade happen, because everything that happens is between you and a programmed algorithm that is launched on a blockchain, and can’t be changed.</p>\n<p>In short, by default, a pool is filled with<strong> a 50/50 ratio of 2 coins.</strong> Let’s say, it’s 50% <a href=https://www.bitdegree.org/"https://www.bitdegree.org/crypto/buy-bitcoin-btc/">Bitcoin, and 50% <a href=https://www.bitdegree.org/"https://www.bitdegree.org/crypto/buy-ethereum-eth/">Ethereum. After you start buying Bitcoins with your Ethereum in that pool, the pool starts losing its Bitcoins and obtaining more and more Ethereum coins from you.</p>\n<p>In this case, the algorithm of the pool will incrementally raise the price of the Bitcoin and lower the price of Ethereum, because it clearly sees the demand of Bitcoin and the supply of Ethereum. This is the automated pool reaction to the market needs, everything is self-regulated.</p>\n<p>Also, this illustration answers the question why liquidity pools are looking for more and more liquidity investors. And the answer is - the bigger the pool and sum of assets in it, the less it’s sensitive to massive buy and sell trades, and the price algorithm of the assets stays less sensitive to the market itself, because, with each trade, the pool will obtain or lose just a little amount of assets, when compared to the whole liquidity pool size.</p>\n<p>Now, allow me to be clear - the processes behind liquidity pools are <strong>far more complicated than that. </strong>There are a ton of different features related to these projects, and each pool needs to be developed and programmed using smart contracts and advanced coding logic.</p>\n<p>For your average person, though, all of that is trivial. You aren’t going to need to know the intricacies of liquidity pools in order to use them. Suffice to say that liquidity pools hold two or more assets (cryptocurrencies, USD, and so on) inside of them, and allow people to trade on decentralized exchange platforms.</p>\n<p>In turn, while individuals use the pools for their trades, investors will receive interest on their investments, over time. <em>Simple!</em></p>\n<h2>Why are Liquidity Pools Useful?</h2>\n<p>Now that you have a better idea of what liquidity pools are and how they work, let’s explore the concept of why anyone would want to use these pools in the first place.</p>\n<p><img style=\"display: block; margin-left: auto; margin-right: auto;\" title=\"\" src=https://www.bitdegree.org/"https://assets.bitdegree.org/crypto/storage/media/what-is-liquidity-pool-4.o.jpg/" alt=\"What is liquidity pool in crypto: Why are liquidity pools useful?\" width=\"800\" height=\"314\" /></p>\n<p>We’ve already covered the very general ideas of why someone might want to use liquidity pools - investors want to <strong>earn a premium,</strong> while traders are able to <strong>trade the cryptocurrencies</strong> that they want, on decentralized exchanges, thanks to those same liquidity pools. However, the reasoning goes much deeper, too.</p>\n<p>Imagine that you’re trading on a centralized, well-known cryptocurrency exchange. Suddenly, the price of Bitcoin drops by 40%, out of the blue. What do you think happens next?</p>\n<p>If you said “panic”, you’re definitely correct.</p>\n<p><img style=\"display: block; margin-left: auto; margin-right: auto;\" title=\"\" src=https://www.bitdegree.org/"https://assets.bitdegree.org/crypto/storage/media/what-is-liquidity-pool-5.o.jpg/" alt=\"What is liquidity pool in crypto: Trading on a centralized crypto exchange.\" width=\"801\" height=\"297\" /></p>\n<p>Fearing further price plunges, thousands of traders and their pets rush to the exchange, in order to sell their BTC. While all of this is happening, the CEO of the exchange sees that the situation is dire - they are running out of fiat money, and their servers are crashing.</p>\n<p>The CEO decides to freeze the transactions - in other words, you are no longer able to sell your BTC on the exchange. Just to be clear, the managing staff of a <a href=https://www.bitdegree.org/"/crypto/learn/crypto-terms/what-is-centralized-exchange-cex/">centralized exchange</strong></a> is always prepared to pull the kill-switch, and to turn off our trading party if a situation starts moving away from their interests.</p>\n<p>THIS is exactly why decentralized exchanges are popular and useful. <strong>No one person can dictate what happens with a DEX</strong> simply because he got out of bed on the wrong foot that morning. And liquidity pools allow these DEXs to remain decentralized, in the first place!</p>\n<p>On top of that, if the aforementioned CEO freezes the operations of their exchange, as discussed earlier, this will impact the price further - people will start panicking even more! On a decentralized exchange, liquidity pools are the ones that dictate the price of an asset - they are not impacted by bad mood or weather<em>. </em></p>\n<p>Sure, the price will follow the market, but it will be <strong>less prone to various forms of manipulation. </strong>Once again, this is thanks to the logic behind liquidity pool development.</p>\n<p>Also let’s not forget about market-making mechanisms on some centralized exchanges, where sneaky exchange owners deal with specific coin creators so that the exchange will move their coins by buying and selling them hundreds of times, without any fee, to create a volume and some sort of activity of the so-called “<a href=https://www.bitdegree.org/"/crypto/learn/crypto-terms/what-is-shitcoin/">shitcoin”, to make it look like an active project with thousands of active transactions, buyers and sellers.</p>\n<p><img style=\"display: block; margin-left: auto; margin-right: auto;\" title=\"\" src=https://www.bitdegree.org/"https://assets.bitdegree.org/crypto/storage/media/what-is-liquidity-pool-6.o.jpg/" alt=\"What is liquidity pool in crypto: Market-making mechanism.\" width=\"801\" height=\"196\" /></p>\n<p>By doing so, they try to imitate activity and look prettier to potential investors on the market. And this is one of the darkest things on centralized exchanges, especially with new, less-known altcoins.</p>\n<p>Another use for liquidity pools among traders is “<a href=https://www.bitdegree.org/"/crypto/learn/crypto-terms/what-is-arbitrage/">arbitrage trading</strong></a>”. A very fancy term, sure, but the concept is actually very simple! Traders try to search for many liquidity pools with the best prices of an asset lying within, and then buy that asset, so that they could trade it on centralized or even other decentralized exchanges, and make a profit with a difference in doing so.</p>\n<p>Let's imagine a trader finds the DEX that currently trades some coin or token for $50 per coin. After buying these tokens, he goes to a different exchange with a higher bid price for the same coin and sells it there for $51 per coin. By doing so, his profit is $1 per coin, and this is huge!</p>\n<p><img style=\"display: block; margin-left: auto; margin-right: auto;\" title=\"\" src=https://www.bitdegree.org/"https://assets.bitdegree.org/crypto/storage/media/what-is-liquidity-pool-7.o.jpg/" alt=\"What is liquidity pool in crypto: Arbitrage trading.\" width=\"800\" height=\"469\" /></p>\n<p>Arbitrage trading requires a lot of experience and discipline, but it’s one of the more common uses for liquidity pools, nonetheless. It’s made possible due to the <strong>common asset price differences</strong> between centralized exchanges and liquidity pools.</p>\n<p>All in all, there’s a lot more when it comes to liquidity pools, but the information discussed in this section should serve as a great starting point for beginners.</p>","preview_url":"https://www.bitdegree.org/crypto/learn/what-is-liquidity-pool-in-crypto","youtube_video":{"id":3,"channel_id":1,"sort":53,"video_title":"What is a Liquidity Pool in Crypto? (Animated)","description":"What is a liquidity pool in crypto?\n\nLiquidity pools are special tools that allow people to trade their cryptocurrencies even if there is no buyer or seller available otherwise. A liquidity pool allows people to trade some niche and less-known crypto assets, as well as earn a passive income, if you’re a liquidity provider.\n\nLiquidity pools are definitely among the more-complicated topics in crypto. However, in this video, I’ll break them down in a simple-to-understand manner, so that the topic would become approachable to even complete beginners! We’ll cover what liquidity pools are, how do they work, and why are they useful, in the first place.\n\nHave you ever used a liquidity pool yourself? Perhaps you’re a liquidity provider right now? Let me know in the comments down below!\n\nVideo Time Table:\n\n0:00 Introduction to What is a Liquidity Pool in Crypto\n0:59 What is a Liquidity Pool in Crypto?\n2:42 How do Liquidity Pools Work?\n7:21 Why Are Liquidity Pools Useful?\n10:51 Wrap-up: What is a Liquidity Pool in Crypto?\n\nGet Quick Crypto Tips on Twitter - Follow:\nhttps://twitter.com/crypto_xplained\n\n#LiquidityPool #WhatisaLiquidityPool #WhatisLiquidityPoolinCrypto #WhatisCryptoLiquidityPool #UniswapLiquidityPool","video_id":"X8J3qSI3avg","duration":668,"view_count":1004,"thumbnail_url":"https://i.ytimg.com/vi/X8J3qSI3avg/hq720.jpg","thumbnail_width":1280,"thumbnail_height":720,"published_at":"2022-02-10 15:27:12","created_at":"2022-02-21T13:20:28.000000Z","updated_at":"2023-05-21T23:00:04.000000Z","channel":{"id":1,"title":"CryptoFinallyExplained","channel_id":"UCOryUY0yxC08eJtK23mNgiA","main_playlist_id":"UUOryUY0yxC08eJtK23mNgiA"}}},"chapterTitle":"dApps & Defi","cryptoBookSection":{"id":23,"featured_image_id":null,"original_id":null,"youtube_video_id":24,"author_id":40,"translator_id":null,"chapter_id":6,"title":"Automated Market Maker: the Cornerstone of the Decentralized Crypto Exchange Industry","slug":"what-is-automated-market-maker","definition":"Did you know that Automated Market Makers provide the possibility for users to become liquidity providers in exchange for a share of transaction fees and free tokens?","status":"published","content":"<p>In this section, we’re going to cover what is an Automated Market Maker!</p>\n<p>Automated Market Makers, also known as <strong>AMMs</strong> - are special, complex algorithms that are designed to help people trade certain cryptocurrency assets with <a href=https://www.bitdegree.org/"/crypto/learn/crypto-terms/what-is-decentralized-exchange-dex/">decentralized crypto exchanges</strong></a>. These algorithms react to the supply and demand factors automatically and allow traders to interact with them without needing another, real person to be present on the other side of a trade.</p>\n<p>Automated Market Makers are also one of the cornerstones of the decentralized crypto exchange industry. Without AMMs, DEXs - the decentralized exchanges, wouldn’t really be able to exist and function, at least not in the way that they do now, and here I’ll explain why!</p>\n<p>In this section, I will explain to you what an Automated Market Maker is, and how Automated Market Makers work!</p>\n<p>Let’s get to it!</p>\n<h2>What is an Automated Market Maker?</h2>\n<p>So, it’s definitely no secret that Automated Market Making is one of the more-difficult topics in the cryptocurrency world. That’s mostly due to all of the technicalities surrounding it, as well as the fact that it’s covered with <strong>industry-specific</strong> jargon.</p>\n<p>So, imagine that you live in a village, on an island, where everyone only uses forks, and no other eating utensils. Forks are great, but eating soup with them can be really difficult! With all of the abundance of forks that you have, other utensils would be great!</p>\n<p><img style=\"display: block; margin-left: auto; margin-right: auto;\" title=\"\" src=https://www.bitdegree.org/"https://assets.bitdegree.org/crypto/storage/media/what-is-automated-market-maker-01.o.jpg/" alt=\"What is an Automated Market Maker: An example with an island.\" width=\"1000\" height=\"412\" /></p>\n<p>One day, a ship comes to visit your island. The captain of that ship tells you that he’s a businessman, and that he just left another island where the residents only had spoons. Coincidentally, the spoon-island residents would really love to have some forks at their disposal!</p>\n<p>The captain proposes a deal to you - he will give you his ship that will travel between islands, and allow people to trade spoons and forks. All that this ship needs for this to work is an initial supply of utensils on both ends - say, 1000 forks, and 1000 spoons.</p>\n<p>So to sum up, in the real world, the businessman from my story is the decentralized exchange, the ship is an Automated Market Maker and all of the <strong>goods</strong> that it transports are cryptocurrencies.</p>\n<h2>How do AMMs work?</h2>\n<p>Now, let’s stop right there. We’ll continue with the example moving forward, but allow me to first explain the premise of Automated Market Makers.</p>\n<p>So, in our example, the forks and spoons would be two different cryptocurrencies - let’s call them <strong>FORK coin, and SPOON coin.</strong> The special ship that would travel between islands acts as the Automated Market Maker. So, essentially, in order for an AMM to function, you need to have two types of cryptocurrencies within it.</p>\n<p>The catch here is that, when starting out, the Automated Market Maker should have an equal amount of both cryptocurrencies. I’ll explain why that’s the case soon, but essentially, that’s the way that <strong>the algorithm works</strong>.</p>\n<p>So, with that cleared up, let’s get back to our example.</p>\n<p>You agree to put 1000 forks into the special ship, while the residents of the other island agree to add 1000 spoons. All of these new utensils are stored on the special ship, but there’s a catch - the ship will keep your utensils arranged and tidy, but the value ratio for both the forks and the spoons must ALWAYS remain the same.</p>\n<p style=\"text-align: center;\"><img title=\"\" src=https://www.bitdegree.org/"https://assets.bitdegree.org/crypto/storage/media/What-is-Automated-Market-Maker-03.o.jpg/" alt=\"What is an Automated Market Maker: x=y (at the start).\" width=\"1000\" height=\"723\" /></p>\n<p>How would this be ensured? Simple - since there are 1000 forks and 1000 spoons on the ship, their joint value must always be 1 million. This value of goods is the result of multiplying the forks and the spoons.</p>\n<p>What you’ve just witnessed is the core formula behind the Automated Market Making algorithm - in other words, it’s the essential rule that allows for AMMs to function properly! Written as a naked formula, it would look like this:</p>\n<p><strong>X * Y = k</strong></p>\n<p>Here, X is the forks, and Y is the spoons. The “k” stands for the result of the multiplication - a number that must ALWAYS remain the same in this equation, no matter what. In our example, it’s 1 million.</p>\n<p>Why is this as important as it is? Well, take a closer look.</p>\n<p>Say, you’ve noticed that there’s already a shortage of spoons on your island. You go to the special ship, and give it 200 forks. How many spoons would you receive back?</p>\n<p>If you said 200, that’s actually wrong! The actual answer is 167. I know it may seem confusing, but check it out - it’s actually pretty simple!</p>\n<p><img style=\"display: block; margin-left: auto; margin-right: auto;\" title=\"\" src=https://www.bitdegree.org/"https://assets.bitdegree.org/crypto/storage/media/What-is-Automated-Market-Maker-02.o.jpg/" alt=\"What is an Automated Market Maker: How do AMMs work?\" width=\"1000\" height=\"546\" /></p>\n<p>The special ship has 1000 forks, and 1000 spoons on it. You want to give it more forks, in exchange for spoons. This means that there will be significantly fewer spoons than forks on the ship left, after the trade! This, in turn, makes the spoons more valuable, since there’s <strong>a higher demand</strong> for them!</p>\n<p>How do you get 167? Well, first, you need to add your forks to the ship - that would total 1200 forks on deck. Then, you need to take the constant value number - 1 million -, and divide it by 1200. The result is 833. Now, simply subtract this number from the 1000 available spoons on the ship, and you get 167 - the number of spoons that you would get for your 200 forks!</p>\n<p>Jumping back to Automated Market Making, this premise is very simple. As you trade the assets available on the AMM platform, the less of an asset that there is available to be traded, the more valuable and expensive it will become! So, if you want to give the Automated Market Maker your FORK coins in exchange for SPOON coins, and this trade would result in the number of SPOON coins plummeting on the platform, naturally, their price will increase.</p>\n<p>Who or what exactly are you giving your coins to, and getting new coins from? Well, the “special ship” in our example has an even more special fuel tank - it’s actually called a “<a href=https://www.bitdegree.org/"/crypto/learn/crypto-terms/what-is-liquidity-pool/">liquidity pool</strong></a>”.</p>\n<p>If you know a few things about crypto, everything might have just clicked in your head. If not, and this term is completely new to you, I would highly recommend reading a dedicated section on <a href=https://www.bitdegree.org/"/crypto/learn/what-is-liquidity-pool-in-crypto/">liquidity pools</strong></a>, so as to get a better understanding of what this concept is.</p>\n<p>Generally speaking, liquidity pools allow Automated Market Makers to function the way that they do. Within the pool, you’ll find two cryptocurrencies - in our case, those would be the FORK and SPOON coins.</p>\n<p>As you interact and trade with the Automated Market Maker, it automatically checks to see what the situation is within the pool - in other words, whether or not certain coins are getting <strong>lower</strong> on supply, and <strong>higher</strong> on demand. If that’s the case, the AMM then adjusts the price for each cryptocurrency, according to the formula I mentioned earlier.</p>\n<p>It should also be noted that all of these processes happen in a matter of milliseconds!</p>\n<p>What’s very important to take away from all of this is the fact that an Automated Market Maker - or, more specifically, the liquidity pool that the AMM uses - needs to start with an equal amount of two assets, in order to establish the “k” value in our formula.</p>\n<p>That’s because this value will then be used to calculate and recalculate the prices (or values) of the coins, each time that a transaction happens.</p>\n<p>So, now that you know what an Automated Market Maker is, your next question might be - what is this tool even used for? Can’t people just <strong>trade</strong> with one another, without all of these complicated tools?</p>\n<p>To tell you the truth, AMMs are an amazing invention, and they are essential in keeping places such as decentralized cryptocurrency exchanges alive and functional! Automated Market Makers allow people to trade their assets of choice, without a need for there to be another person that would be interested in performing that trade, at the same point in time. So basically, at decentralized exchanges, you, as a person, will trade with a machine, not with a human.</p>\n<p>Imagine that you want to trade your <a href=https://www.bitdegree.org/"/crypto/buy-ethereum-eth/">Ethereum coins for some <a href=https://www.bitdegree.org/"/crypto/buy-bitcoin-btc/">Bitcoin. Doing it the old-fashioned way, you would need to wait for someone else who would want to trade their BTC for ETH, and if all of the parameters of the trade match, you would be able to perform that trade.</p>\n<p>When we use Ethereum and Bitcoin as examples, it might seem almost comical. However, don’t forget that there are plenty of far less-known crypto assets out there, on the market! This means that you could be waiting for someone to match your trade for a long amount of time.</p>\n<p><img style=\"display: block; margin-left: auto; margin-right: auto;\" title=\"\" src=https://www.bitdegree.org/"https://assets.bitdegree.org/crypto/storage/media/What-is-Automated-Market-Maker-05.o.jpg/" alt=\"What is an Automated Market Maker: Trading less-known crypto assets.\" width=\"1000\" height=\"518\" /></p>\n<p>Not an issue with Automated Market Makers, however. With these tools on decentralized exchanges, you can perform your trades instantly!</p>\n<p>On another point, liquidity pools are also a method of how cryptocurrency enthusiasts are able to earn<strong> a passive income</strong>, too! Other sections cover <a href=https://www.bitdegree.org/"/crypto/learn/what-is-staking-in-crypto/">staking and <a href=https://www.bitdegree.org/"/crypto/learn/what-is-liquidity-pool-in-crypto/">liquidity pools</strong></a>, so make sure to check those out - however, let’s go over the general premise here.</p>\n<p>If you remember the beginning of the section, at the start of my example, I mentioned that 1000 forks and 1000 spoons are needed in order for the special ship to start working. Well, someone needs to supply all of those forks and spoons - in other words, someone needs to bring their cryptocurrencies to the liquidity pools. This doesn’t just happen out of thin air!</p>\n<p><img style=\"display: block; margin-left: auto; margin-right: auto;\" title=\"\" src=https://www.bitdegree.org/"https://assets.bitdegree.org/crypto/storage/media/What-is-Automated-Market-Maker-06.o.jpg/" alt=\"What is an Automated Market Maker: Liquidity pool.\" width=\"1000\" height=\"361\" /></p>\n<p>The people that supply these crypto assets are called liquidity providers, or simply - <strong>investors</strong>. The way how Automated Market Makers work is by rewarding the investors with a small percentage of coins, from each transaction happening in the pool. This way, with time, investors are able to make a profit, while crypto traders are able to trade coins that they want, with the Automated Market Makers!</p>\n<h2>Conclusion</h2>\n<p>It’s worth emphasizing that this is just the very general premise of how Automated Market Makers work. Nowadays, these algorithms are becoming more complex, and the more time you spend studying them, the more questions they will raise!</p>\n<p>Just think about it this way - in this section, this Automated Market Maker example included two cryptocurrencies. Well, what if the AMM works with not two, but three, four, five, or more crypto assets all at once? Then, <strong>the formula</strong> becomes even more intricate!</p>\n<p>So, we've come to an end, I do hope that you’ve learned a lot! If you would like to learn more about the world of crypto check out the section about <a href=https://www.bitdegree.org/"/crypto/learn/what-is-web-3-0/">Web 3.0</strong></a>!</p>","meta_title":"What is an Automated Market Maker: An In-Depth Explanation","meta_description":"Wondering what is an Automated Market Maker in crypto? In this section, you'll find out how it works with some easy-to-understand examples.","meta_keywords":"what is an automated market maker, automated market maker crypto, automated market maker formula, automated market maker example, automated market maker explained, how does an automated market maker work, automated market maker platforms,","order":10,"language":"en","created_at":"2022-05-05T11:52:23.000000Z","updated_at":"2023-03-10T08:17:31.000000Z","modified_content":"<p>In this section, we’re going to cover what is an Automated Market Maker!</p>\n<p>Automated Market Makers, also known as <strong>AMMs</strong> - are special, complex algorithms that are designed to help people trade certain cryptocurrency assets with <a href=https://www.bitdegree.org/"/crypto/learn/crypto-terms/what-is-decentralized-exchange-dex/">decentralized crypto exchanges</strong></a>. These algorithms react to the supply and demand factors automatically and allow traders to interact with them without needing another, real person to be present on the other side of a trade.</p>\n<p>Automated Market Makers are also one of the cornerstones of the decentralized crypto exchange industry. Without AMMs, DEXs - the decentralized exchanges, wouldn’t really be able to exist and function, at least not in the way that they do now, and here I’ll explain why!</p>\n<p>In this section, I will explain to you what an Automated Market Maker is, and how Automated Market Makers work!</p>\n<p>Let’s get to it!</p>\n<div class=\"container\">\n <div class=\"row justify-content-center\">\n <div class=\"col-md-10 comparison-suggestion pb-3 mb-4\">\n <div class=\"d-flex flex-row\">\n <div class=\"text-center\">\n <div class=\"img-block-yt\">\n <img src=https://www.bitdegree.org/"https://assets.bitdegree.org/crypto/assets/images/compare-crypto-exchanges.gif/"/n alt=\"What is an Automated Market Maker in Crypto? (Animated)\"\n title=\"What is an Automated Market Maker in Crypto? (Animated)\" class=\"border-0\">\n <p>Video Explainer</p>\n </div>\n </div>\n <div class=\"col-xs-10 col-sm-10 col-md-10 text-left py-3 yt-info\">\n <h4 class=\"mb-1\">Video Explainer: Automated Market Maker: the Cornerstone of the Decentralized Crypto Exchange Industry</h4>\n <p class=\"py-1 mb-0 youtube-video-subtitle\">Reading is not your thing? Watch the \"Automated Market Maker: the Cornerstone of the Decentralized Crypto Exchange Industry\" video explainer</p>\n </div>\n </div>\n <div class=\"row justify-content-center text-center\">\n <div class=\"col-12 col-md-11 px-3\">\n <div class=\"wrapper mb-0\">\n <div class=\"youtube mb-4 bg-transparent p-0 video-modal-popup\" data-toggle=\"modal\"\n data-target=\"#video-modal\" data-id=\"eSje8ikWTls\" data-title=\"CryptoFinallyExplained\">\n <div class=\"video-gradient-top\"></div>\n <p class=\"text-left dyk-video-title\">What is an Automated Market Maker in Crypto? (Animated)</p>\n <img src=https://www.bitdegree.org/"https://i.ytimg.com/vi/eSje8ikWTls/hq720.jpg/"/n alt=\"What is an Automated Market Maker in Crypto? (Animated)\"\n title=\"What is an Automated Market Maker in Crypto? (Animated)\"\n class=\"p-0\">\n <img class=\"play-button\" data-target=\"#video-modal\"\n src=https://www.bitdegree.org/"https://assets.bitdegree.org/crypto/assets/video-button.png/"/n alt=\"What is an Automated Market Maker in Crypto? (Animated)\">\n </div>\n </div>\n </div>\n </div>\n <div class=\"row justify-content-center text-center\">\n <div>\n <a href=https://www.bitdegree.org/"https://www.youtube.com/c/CryptoFinallyExplained?sub_confirmation=1\%22\n class=\"btn yt-promo mb-2\" target=\"_blank\" rel=\"nofollow noopener\">\n <div class=\"row justify-content-center align-items-center mx-0 text-center\">\n <div class=\"col-4 col-md-4\">\n <i class=\"fab fa-youtube yt-dyk-btn\"></i>\n </div>\n <div class=\"col-8 col-md-8 text-center yt-promo-text\">\n <h4 class=\"m-0 text-white\">SUBSCRIBE</h4>\n <span>ON YOUTUBE</span>\n </div>\n </div>\n </a>\n </div>\n </div>\n </div>\n </div>\n</div>\n<div class=\"modal fade\" id=\"video-modal\" tabindex=\"-1\" role=\"dialog\" aria-labelledby=\"eSje8ikWTls\">\n <div class=\"modal-dialog modal-dialog-centered modal-lg\" role=\"document\">\n <div class=\"modal-content\">\n <div class=\"modal-body p-0\">\n <button type=\"button\" class=\"video-modal-close close\" data-dismiss=\"modal\" aria-label=\"Close\">\n <i aria-hidden=\"true\" class=\"fas fa-times\"></i>\n </button>\n <div id=\"iframe\"></div>\n </div>\n <a class=\"text-decoration-none\"\n href=https://www.bitdegree.org/"https://www.youtube.com/c/CryptoFinallyExplained?sub_confirmation=1\%22\n rel=\"nofollow noopener\" target=\"_blank\">\n <div class=\"modal-footer p-0 d-block bg-white\">\n <div class=\"row justify-content-center m-0\">\n <div class=\"col-3 col-md-4 col-lg-2 p-0\">\n <img class=\"w-100 h-100\" src=https://www.bitdegree.org/"https://assets.bitdegree.org/crypto/assets/crypto-subscribe.jpg/" alt=\"Subscribe\">\n </div>\n <div class=\"col-9 col-md-8 col-lg-2 px-0 d-flex\">\n <div class=\"modal-subscribe w-100\">\n <p class=\"m-0 mt-1 mr-3\">SUBSCRIBE<br>\n <span class=\"m-0\">ON YOUTUBE</span>\n </p>\n </div>\n </div>\n <div class=\"col-12 col-md-12 col-lg-8 p-0 text-center d-flex justify-content-center align-items-center\">\n <div class=\"modal-subscribe-text\">\n <h4 class=\"m-0\">Understand crypto with ease</h4>\n <span>New explainer videos every week!</span>\n </div>\n </div>\n </div>\n </div>\n </a>\n </div>\n </div>\n</div>\n<h2>What is an Automated Market Maker?</h2>\n<p>So, it’s definitely no secret that Automated Market Making is one of the more-difficult topics in the cryptocurrency world. That’s mostly due to all of the technicalities surrounding it, as well as the fact that it’s covered with <strong>industry-specific</strong> jargon.</p>\n<p>So, imagine that you live in a village, on an island, where everyone only uses forks, and no other eating utensils. Forks are great, but eating soup with them can be really difficult! With all of the abundance of forks that you have, other utensils would be great!</p>\n<p><img style=\"display: block; margin-left: auto; margin-right: auto;\" title=\"\" src=https://www.bitdegree.org/"https://assets.bitdegree.org/crypto/storage/media/what-is-automated-market-maker-01.o.jpg/" alt=\"What is an Automated Market Maker: An example with an island.\" width=\"1000\" height=\"412\" /></p>\n<p>One day, a ship comes to visit your island. The captain of that ship tells you that he’s a businessman, and that he just left another island where the residents only had spoons. Coincidentally, the spoon-island residents would really love to have some forks at their disposal!</p>\n<p>The captain proposes a deal to you - he will give you his ship that will travel between islands, and allow people to trade spoons and forks. All that this ship needs for this to work is an initial supply of utensils on both ends - say, 1000 forks, and 1000 spoons.</p>\n<p>So to sum up, in the real world, the businessman from my story is the decentralized exchange, the ship is an Automated Market Maker and all of the <strong>goods</strong> that it transports are cryptocurrencies.</p>\n<h2>How do AMMs work?</h2>\n<p>Now, let’s stop right there. We’ll continue with the example moving forward, but allow me to first explain the premise of Automated Market Makers.</p>\n<p>So, in our example, the forks and spoons would be two different cryptocurrencies - let’s call them <strong>FORK coin, and SPOON coin.</strong> The special ship that would travel between islands acts as the Automated Market Maker. So, essentially, in order for an AMM to function, you need to have two types of cryptocurrencies within it.</p>\n<p>The catch here is that, when starting out, the Automated Market Maker should have an equal amount of both cryptocurrencies. I’ll explain why that’s the case soon, but essentially, that’s the way that <strong>the algorithm works</strong>.</p>\n<p>So, with that cleared up, let’s get back to our example.</p>\n<p>You agree to put 1000 forks into the special ship, while the residents of the other island agree to add 1000 spoons. All of these new utensils are stored on the special ship, but there’s a catch - the ship will keep your utensils arranged and tidy, but the value ratio for both the forks and the spoons must ALWAYS remain the same.</p>\n<p style=\"text-align: center;\"><img title=\"\" src=https://www.bitdegree.org/"https://assets.bitdegree.org/crypto/storage/media/What-is-Automated-Market-Maker-03.o.jpg/" alt=\"What is an Automated Market Maker: x=y (at the start).\" width=\"1000\" height=\"723\" /></p>\n<p>How would this be ensured? Simple - since there are 1000 forks and 1000 spoons on the ship, their joint value must always be 1 million. This value of goods is the result of multiplying the forks and the spoons.</p>\n<p>What you’ve just witnessed is the core formula behind the Automated Market Making algorithm - in other words, it’s the essential rule that allows for AMMs to function properly! Written as a naked formula, it would look like this:</p>\n<p><strong>X * Y = k</strong></p>\n<p>Here, X is the forks, and Y is the spoons. The “k” stands for the result of the multiplication - a number that must ALWAYS remain the same in this equation, no matter what. In our example, it’s 1 million.</p>\n<p>Why is this as important as it is? Well, take a closer look.</p>\n<p>Say, you’ve noticed that there’s already a shortage of spoons on your island. You go to the special ship, and give it 200 forks. How many spoons would you receive back?</p>\n<p>If you said 200, that’s actually wrong! The actual answer is 167. I know it may seem confusing, but check it out - it’s actually pretty simple!</p>\n<p><img style=\"display: block; margin-left: auto; margin-right: auto;\" title=\"\" src=https://www.bitdegree.org/"https://assets.bitdegree.org/crypto/storage/media/What-is-Automated-Market-Maker-02.o.jpg/" alt=\"What is an Automated Market Maker: How do AMMs work?\" width=\"1000\" height=\"546\" /></p>\n<p>The special ship has 1000 forks, and 1000 spoons on it. You want to give it more forks, in exchange for spoons. This means that there will be significantly fewer spoons than forks on the ship left, after the trade! This, in turn, makes the spoons more valuable, since there’s <strong>a higher demand</strong> for them!</p>\n<p>How do you get 167? Well, first, you need to add your forks to the ship - that would total 1200 forks on deck. Then, you need to take the constant value number - 1 million -, and divide it by 1200. The result is 833. Now, simply subtract this number from the 1000 available spoons on the ship, and you get 167 - the number of spoons that you would get for your 200 forks!</p>\n<p>Jumping back to Automated Market Making, this premise is very simple. As you trade the assets available on the AMM platform, the less of an asset that there is available to be traded, the more valuable and expensive it will become! So, if you want to give the Automated Market Maker your FORK coins in exchange for SPOON coins, and this trade would result in the number of SPOON coins plummeting on the platform, naturally, their price will increase.</p>\n<p>Who or what exactly are you giving your coins to, and getting new coins from? Well, the “special ship” in our example has an even more special fuel tank - it’s actually called a “<a href=https://www.bitdegree.org/"/crypto/learn/crypto-terms/what-is-liquidity-pool/">liquidity pool</strong></a>”.</p>\n<p>If you know a few things about crypto, everything might have just clicked in your head. If not, and this term is completely new to you, I would highly recommend reading a dedicated section on <a href=https://www.bitdegree.org/"/crypto/learn/what-is-liquidity-pool-in-crypto/">liquidity pools</strong></a>, so as to get a better understanding of what this concept is.</p>\n<p>Generally speaking, liquidity pools allow Automated Market Makers to function the way that they do. Within the pool, you’ll find two cryptocurrencies - in our case, those would be the FORK and SPOON coins.</p>\n<p>As you interact and trade with the Automated Market Maker, it automatically checks to see what the situation is within the pool - in other words, whether or not certain coins are getting <strong>lower</strong> on supply, and <strong>higher</strong> on demand. If that’s the case, the AMM then adjusts the price for each cryptocurrency, according to the formula I mentioned earlier.</p>\n<p>It should also be noted that all of these processes happen in a matter of milliseconds!</p>\n<p>What’s very important to take away from all of this is the fact that an Automated Market Maker - or, more specifically, the liquidity pool that the AMM uses - needs to start with an equal amount of two assets, in order to establish the “k” value in our formula.</p>\n<p>That’s because this value will then be used to calculate and recalculate the prices (or values) of the coins, each time that a transaction happens.</p>\n<p>So, now that you know what an Automated Market Maker is, your next question might be - what is this tool even used for? Can’t people just <strong>trade</strong> with one another, without all of these complicated tools?</p>\n<p>To tell you the truth, AMMs are an amazing invention, and they are essential in keeping places such as decentralized cryptocurrency exchanges alive and functional! Automated Market Makers allow people to trade their assets of choice, without a need for there to be another person that would be interested in performing that trade, at the same point in time. So basically, at decentralized exchanges, you, as a person, will trade with a machine, not with a human.</p>\n<p>Imagine that you want to trade your <a href=https://www.bitdegree.org/"/crypto/buy-ethereum-eth/">Ethereum coins for some <a href=https://www.bitdegree.org/"/crypto/buy-bitcoin-btc/">Bitcoin. Doing it the old-fashioned way, you would need to wait for someone else who would want to trade their BTC for ETH, and if all of the parameters of the trade match, you would be able to perform that trade.</p>\n<p>When we use Ethereum and Bitcoin as examples, it might seem almost comical. However, don’t forget that there are plenty of far less-known crypto assets out there, on the market! This means that you could be waiting for someone to match your trade for a long amount of time.</p>\n<p><img style=\"display: block; margin-left: auto; margin-right: auto;\" title=\"\" src=https://www.bitdegree.org/"https://assets.bitdegree.org/crypto/storage/media/What-is-Automated-Market-Maker-05.o.jpg/" alt=\"What is an Automated Market Maker: Trading less-known crypto assets.\" width=\"1000\" height=\"518\" /></p>\n<p>Not an issue with Automated Market Makers, however. With these tools on decentralized exchanges, you can perform your trades instantly!</p>\n<p>On another point, liquidity pools are also a method of how cryptocurrency enthusiasts are able to earn<strong> a passive income</strong>, too! Other sections cover <a href=https://www.bitdegree.org/"/crypto/learn/what-is-staking-in-crypto/">staking and <a href=https://www.bitdegree.org/"/crypto/learn/what-is-liquidity-pool-in-crypto/">liquidity pools</strong></a>, so make sure to check those out - however, let’s go over the general premise here.</p>\n<p>If you remember the beginning of the section, at the start of my example, I mentioned that 1000 forks and 1000 spoons are needed in order for the special ship to start working. Well, someone needs to supply all of those forks and spoons - in other words, someone needs to bring their cryptocurrencies to the liquidity pools. This doesn’t just happen out of thin air!</p>\n<p><img style=\"display: block; margin-left: auto; margin-right: auto;\" title=\"\" src=https://www.bitdegree.org/"https://assets.bitdegree.org/crypto/storage/media/What-is-Automated-Market-Maker-06.o.jpg/" alt=\"What is an Automated Market Maker: Liquidity pool.\" width=\"1000\" height=\"361\" /></p>\n<p>The people that supply these crypto assets are called liquidity providers, or simply - <strong>investors</strong>. The way how Automated Market Makers work is by rewarding the investors with a small percentage of coins, from each transaction happening in the pool. This way, with time, investors are able to make a profit, while crypto traders are able to trade coins that they want, with the Automated Market Makers!</p>\n<h2>Conclusion</h2>\n<p>It’s worth emphasizing that this is just the very general premise of how Automated Market Makers work. Nowadays, these algorithms are becoming more complex, and the more time you spend studying them, the more questions they will raise!</p>\n<p>Just think about it this way - in this section, this Automated Market Maker example included two cryptocurrencies. Well, what if the AMM works with not two, but three, four, five, or more crypto assets all at once? Then, <strong>the formula</strong> becomes even more intricate!</p>\n<p>So, we've come to an end, I do hope that you’ve learned a lot! If you would like to learn more about the world of crypto check out the section about <a href=https://www.bitdegree.org/"/crypto/learn/what-is-web-3-0/">Web 3.0</strong></a>!</p>","preview_url":"https://www.bitdegree.org/crypto/learn/what-is-automated-market-maker","youtube_video":{"id":24,"channel_id":1,"sort":38,"video_title":"What is an Automated Market Maker in Crypto? (Animated)","description":"What is an Automated Market Maker?\n\nAutomated Market Makers are special tools designed to allow cryptocurrency traders to trade different coins and tokens with a computer, instead of doing so with another human being. AMMs utilize liquidity pools, and use algorithms in order to calculate the prices of each asset that they support for the trades.\n\nAutomated Market Makers can seem intimidating and complex, but when broken down, they aren’t all that tough to get your head around. In this video, I will tell you exactly what an Automated Market Maker is, and also, how does it work - with examples!\n\nHave you ever used an AMM before? Share your experiences in the comments down below!\n\nVideo Time Table:\n0:00 Introduction to What is an Automated Market Maker in Crypto\n0:59 What is an Automated Market Maker?\n3:31 How do Automated Market Makers work?\n8:50 Wrap-up: What is an Automated Market Maker in Crypto?\n\nMore Related Videos:\n? What is a Liquidity Pool in Crypto? https://www.youtube.com/watch?v=X8J3qSI3avg\n? What is Yield Farming in Crypto? https://www.youtube.com/watch?v=gZIux6vkz6w\n\nGet Quick Crypto Tips on Twitter - Follow:\nhttps://twitter.com/crypto_xplained\n\n#WhatIsAnAutomatedMarketMaker #AutomatedMarketMakerCrypto #CryptoFinallyExplained","video_id":"eSje8ikWTls","duration":542,"view_count":726,"thumbnail_url":"https://i.ytimg.com/vi/eSje8ikWTls/hq720.jpg","thumbnail_width":1280,"thumbnail_height":720,"published_at":"2022-05-13 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Tokens?","featured_image_id":null,"status":"published","chapter_id":8,"language":"en","order":4,"modified_content":null,"preview_url":"https://www.bitdegree.org/crypto/learn/how-to-track-new-crypto-coins","featured_image":null,"youtube_video":null},{"slug":"how-to-research-crypto","title":"Crypto Research Fundamentals & Social Signals: Your Daily Trading Strategy","featured_image_id":null,"status":"published","chapter_id":8,"language":"en","order":5,"modified_content":null,"preview_url":"https://www.bitdegree.org/crypto/learn/how-to-research-crypto","featured_image":null,"youtube_video":null}]},{"id":9,"title":"Mining","slug":"mining","updated":false,"chapter":"https://assets.bitdegree.org/crypto/assets/crypto-book/chapters/learn-crypto-mining.jpg","chapter_simple":"https://assets.bitdegree.org/crypto/assets/crypto-book/chapters-simple/crypto-mining-101.jpg","rating":80,"sections":[]},{"id":10,"title":"Crypto Terms","updated":false,"chapter":"https://assets.bitdegree.org/crypto/assets/crypto-book/chapters/crypto-101-glossary.jpg","chapter_simple":"https://assets.bitdegree.org/crypto/assets/crypto-book/chapters-simple/crypto-glossary-101.jpg","rating":100,"sections":["A","B","C","D","E","F","G","H","I","J","K","L","M","N","O","P","Q","R","S","T","U","V","W","X","Y","Z"]}],"currentChapter":"dapps-and-defi","currentSection":"what-is-automated-market-maker","readingTime":9,"readingLevel":"medium"},"url":"/crypto/learn/what-is-automated-market-maker","version":"cdd198d50cbe5c9c21c9329d7c096ffc"}" class="container-fluid d-flex crypto-book p-0">
All Crypto From

Scratch!

Crypto 101 Handbook

Chapter 1: Blockchain

1.1

What is the Blockchain?
1.2

Anonymous & Decentralized Blockchains: The Cornerstone of Crypto
1.3

What is a Blockchain Transaction in Crypto?
1.4

The Different Types of Crypto Fees Explained
1.5

The Key Notion Behind the Concept of Bridging in Crypto
1.6

Different Types of Blockchains: What to Look Out For?
Chapter 2: Cryptocurrencies

2.1

What is a Cryptocurrency?
2.2

How Does Cryptocurrency Work?
2.3

Is Cryptocurrency a Good Investment? The Pros & Cons
2.4

Coin VS Token: How Do They Differ?
2.5

What are Stablecoins, Altcoins & Wrapped Coins?
2.6

Bitcoin: the Pioneer of the Crypto World
2.7

The Ultimate Blockchain for dApp Creation: Ethereum
2.8

What is Cardano and What is It Used For?
2.9

Shiba Inu: the Dogecoin Killer
2.10

Is Solana an Improved Version of Ethereum?
2.11

The Bridge Between Blockchains: Polkadot
2.12

Polygon: the Essential Scaling Solution for Ethereum
2.13

The Practical Use of Crypto
Chapter 3: Crypto Exchanges

3.1

How do Cryptocurrency Exchanges Work?
3.2

DEX VS CEX: Two Sides of the Crypto Exchange Industry
3.3

Crypto Day Trading: The Difference Between Buying, Trading, and Swapping
3.4

KYC & AML: The Key to Complying With Legal Industry Standards
3.5

From Fiat to Crypto: How to Buy Crypto for the First Time
3.6

Taking Profits: Turning Crypto Into Fiat
3.7

You’ve Got Crypto: What Can You Do With It?
Chapter 4: Crypto Wallets

4.1

What is a Crypto Wallet?
4.2

Hot Wallet VS Cold Wallet: Which One to Pick?
4.3

What are Non-Custodial Crypto Wallets?
4.4

Metamask: The Leading Non-Custodial Wallet
4.5

The Key Crypto Wallet Safety Practices: How Safe Can Crypto Be?
Chapter 5: NFTs

5.1

What are Non-Fungible Tokens (NFTs)?
5.2

NFT Trading: The Ins and Outs
5.3

Tips and Tricks of Choosing the Right NFTs
5.4

How to Store NFTs: Best Practices
5.5

How to Create Your Own NFTs?
5.6

Making Passive Money with NFTs
Chapter 6: dApps & Defi

6.1

What is Decentralized Finance (DeFi)?
6.2

DeFi 2.0: The New Version of Decentralized Finance
6.3

What Are dApps and How Do They Work?
6.4

Picking the Right dApps: Dos and Don'ts
6.5

Web 3.0: The Future of the Internet
6.6

What is the Core Purpose of Smart Contracts?
6.7

The Notion of a Decentralized Autonomous Ogranization (DAO)
6.8

What is the Goal of Staking Crypto Assets?
6.9

What is a Liquidity Pool and How Does It Work?
6.10

Automated Market Maker: the Cornerstone of the Decentralized Crypto Exchange Industry
6.11

The Main Yield Farming Techniques
6.12

Crypto Oracles: The Link Between Blockchain and Outside World Data
6.13

The Peculiarities of Decentralized Crypto Gambling
6.14

Metaverse: A New Perception of Reality
Chapter 7: Trading & Investing

7.1

Where Can You Trade Cryptocurrencies?
7.2

Investing in Crypto: What Investing Options Do You Have?
7.3

ICO vs IDO vs IEO: Which One is the One?
7.4

What are Crypto Airdrops and How to Get Them?
7.5

How to Get Free Crypto Assets?
7.6

What is Crypto Arbitrage: The Main Principles
7.7

What is FUD: How to Use It to Your Advantage While Investing in Crypto?
7.8

Investing in Cryptocurrency: How to Manage Your Risks?
7.9

What is a Rug Pull in Crypto?
7.10

How to Spot and Avoid Rug Pulls?
7.11

The Key Legal Techniques of Avoiding Crypto Taxes
Chapter 8: Crypto Analysis

8.1

Bearish and Bullish Markets: Do They Matter?
8.2

5 Best Crypto Technical Analysis Indicators You Must Know About
8.3

Technical Analysis: What are Candlesticks, Trendlines, and Patterns?
8.4

Crypto Tracking: How to Track Your Favorite Coins & Tokens?
8.5

Crypto Research Fundamentals & Social Signals: Your Daily Trading Strategy
Chapter 9: Mining

coming soon

Chapter 10: Crypto Terms

10.1

All Crypto Terms

Handbook Cover Page

Chapter 6: dApps & Defi

Automated Market Maker: the Cornerstone of the Decentralized Crypto Exchange Industry

Did you know that Automated Market Makers provide the possibility for users to become liquidity providers in exchange for a share of transaction fees and free tokens?

Medium

9 minutes

Watch Video

In this section, we’re going to cover what is an Automated Market Maker!

Automated Market Makers, also known as AMMs - are special, complex algorithms that are designed to help people trade certain cryptocurrency assets with decentralized crypto exchanges. These algorithms react to the supply and demand factors automatically and allow traders to interact with them without needing another, real person to be present on the other side of a trade.

Automated Market Makers are also one of the cornerstones of the decentralized crypto exchange industry. Without AMMs, DEXs - the decentralized exchanges, wouldn’t really be able to exist and function, at least not in the way that they do now, and here I’ll explain why!

In this section, I will explain to you what an Automated Market Maker is, and how Automated Market Makers work!

Let’s get to it!

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Video Explainer: Automated Market Maker: the Cornerstone of the Decentralized Crypto Exchange Industry

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What is an Automated Market Maker?

So, it’s definitely no secret that Automated Market Making is one of the more-difficult topics in the cryptocurrency world. That’s mostly due to all of the technicalities surrounding it, as well as the fact that it’s covered with industry-specific jargon.

So, imagine that you live in a village, on an island, where everyone only uses forks, and no other eating utensils. Forks are great, but eating soup with them can be really difficult! With all of the abundance of forks that you have, other utensils would be great!

One day, a ship comes to visit your island. The captain of that ship tells you that he’s a businessman, and that he just left another island where the residents only had spoons. Coincidentally, the spoon-island residents would really love to have some forks at their disposal!

The captain proposes a deal to you - he will give you his ship that will travel between islands, and allow people to trade spoons and forks. All that this ship needs for this to work is an initial supply of utensils on both ends - say, 1000 forks, and 1000 spoons.

So to sum up, in the real world, the businessman from my story is the decentralized exchange, the ship is an Automated Market Maker and all of the goods that it transports are cryptocurrencies.

How do AMMs work?

Now, let’s stop right there. We’ll continue with the example moving forward, but allow me to first explain the premise of Automated Market Makers.

So, in our example, the forks and spoons would be two different cryptocurrencies - let’s call them FORK coin, and SPOON coin. The special ship that would travel between islands acts as the Automated Market Maker. So, essentially, in order for an AMM to function, you need to have two types of cryptocurrencies within it.

The catch here is that, when starting out, the Automated Market Maker should have an equal amount of both cryptocurrencies. I’ll explain why that’s the case soon, but essentially, that’s the way that the algorithm works.

So, with that cleared up, let’s get back to our example.

You agree to put 1000 forks into the special ship, while the residents of the other island agree to add 1000 spoons. All of these new utensils are stored on the special ship, but there’s a catch - the ship will keep your utensils arranged and tidy, but the value ratio for both the forks and the spoons must ALWAYS remain the same.

How would this be ensured? Simple - since there are 1000 forks and 1000 spoons on the ship, their joint value must always be 1 million. This value of goods is the result of multiplying the forks and the spoons.

What you’ve just witnessed is the core formula behind the Automated Market Making algorithm - in other words, it’s the essential rule that allows for AMMs to function properly! Written as a naked formula, it would look like this:

X * Y = k

Here, X is the forks, and Y is the spoons. The “k” stands for the result of the multiplication - a number that must ALWAYS remain the same in this equation, no matter what. In our example, it’s 1 million.

Why is this as important as it is? Well, take a closer look.

Say, you’ve noticed that there’s already a shortage of spoons on your island. You go to the special ship, and give it 200 forks. How many spoons would you receive back?

If you said 200, that’s actually wrong! The actual answer is 167. I know it may seem confusing, but check it out - it’s actually pretty simple!

The special ship has 1000 forks, and 1000 spoons on it. You want to give it more forks, in exchange for spoons. This means that there will be significantly fewer spoons than forks on the ship left, after the trade! This, in turn, makes the spoons more valuable, since there’s a higher demand for them!

How do you get 167? Well, first, you need to add your forks to the ship - that would total 1200 forks on deck. Then, you need to take the constant value number - 1 million -, and divide it by 1200. The result is 833. Now, simply subtract this number from the 1000 available spoons on the ship, and you get 167 - the number of spoons that you would get for your 200 forks!

Jumping back to Automated Market Making, this premise is very simple. As you trade the assets available on the AMM platform, the less of an asset that there is available to be traded, the more valuable and expensive it will become! So, if you want to give the Automated Market Maker your FORK coins in exchange for SPOON coins, and this trade would result in the number of SPOON coins plummeting on the platform, naturally, their price will increase.

Who or what exactly are you giving your coins to, and getting new coins from? Well, the “special ship” in our example has an even more special fuel tank - it’s actually called a “liquidity pool”.

If you know a few things about crypto, everything might have just clicked in your head. If not, and this term is completely new to you, I would highly recommend reading a dedicated section on liquidity pools, so as to get a better understanding of what this concept is.

Generally speaking, liquidity pools allow Automated Market Makers to function the way that they do. Within the pool, you’ll find two cryptocurrencies - in our case, those would be the FORK and SPOON coins.

As you interact and trade with the Automated Market Maker, it automatically checks to see what the situation is within the pool - in other words, whether or not certain coins are getting lower on supply, and higher on demand. If that’s the case, the AMM then adjusts the price for each cryptocurrency, according to the formula I mentioned earlier.

It should also be noted that all of these processes happen in a matter of milliseconds!

What’s very important to take away from all of this is the fact that an Automated Market Maker - or, more specifically, the liquidity pool that the AMM uses - needs to start with an equal amount of two assets, in order to establish the “k” value in our formula.

That’s because this value will then be used to calculate and recalculate the prices (or values) of the coins, each time that a transaction happens.

So, now that you know what an Automated Market Maker is, your next question might be - what is this tool even used for? Can’t people just trade with one another, without all of these complicated tools?

To tell you the truth, AMMs are an amazing invention, and they are essential in keeping places such as decentralized cryptocurrency exchanges alive and functional! Automated Market Makers allow people to trade their assets of choice, without a need for there to be another person that would be interested in performing that trade, at the same point in time. So basically, at decentralized exchanges, you, as a person, will trade with a machine, not with a human.

Imagine that you want to trade your Ethereum coins for some Bitcoin. Doing it the old-fashioned way, you would need to wait for someone else who would want to trade their BTC for ETH, and if all of the parameters of the trade match, you would be able to perform that trade.

When we use Ethereum and Bitcoin as examples, it might seem almost comical. However, don’t forget that there are plenty of far less-known crypto assets out there, on the market! This means that you could be waiting for someone to match your trade for a long amount of time.

Not an issue with Automated Market Makers, however. With these tools on decentralized exchanges, you can perform your trades instantly!

On another point, liquidity pools are also a method of how cryptocurrency enthusiasts are able to earn a passive income, too! Other sections cover staking and liquidity pools, so make sure to check those out - however, let’s go over the general premise here.

If you remember the beginning of the section, at the start of my example, I mentioned that 1000 forks and 1000 spoons are needed in order for the special ship to start working. Well, someone needs to supply all of those forks and spoons - in other words, someone needs to bring their cryptocurrencies to the liquidity pools. This doesn’t just happen out of thin air!

The people that supply these crypto assets are called liquidity providers, or simply - investors. The way how Automated Market Makers work is by rewarding the investors with a small percentage of coins, from each transaction happening in the pool. This way, with time, investors are able to make a profit, while crypto traders are able to trade coins that they want, with the Automated Market Makers!

Conclusion

It’s worth emphasizing that this is just the very general premise of how Automated Market Makers work. Nowadays, these algorithms are becoming more complex, and the more time you spend studying them, the more questions they will raise!

Just think about it this way - in this section, this Automated Market Maker example included two cryptocurrencies. Well, what if the AMM works with not two, but three, four, five, or more crypto assets all at once? Then, the formula becomes even more intricate!

So, we've come to an end, I do hope that you’ve learned a lot! If you would like to learn more about the world of crypto check out the section about Web 3.0!

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All Crypto From

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Crypto 101 Handbook

Automated Market Maker: the Cornerstone of the Decentralized Crypto Exchange Industry

Video Explainer: Automated Market Maker: the Cornerstone of the Decentralized Crypto Exchange Industry

What is an Automated Market Maker?

How do AMMs work?

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