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What is Automatic Market Making, and How Does It Work

Liquidity is essential for the success of a crypto project or a crypto trading exchange. Liquidity is what traders look at when deciding whether to invest in or pass by. Liquid tokens can be easily bought and sold anytime without causing price swings. High-liquidity assets are the most attractive for traders, especially for institutional investors that operate with large amounts. Institutional cryptocurrency trading on WhiteBIT and other large exchanges ensures a high liquidity level for investors. Thus, they can be confident about quick, efficient transactions at fair prices.

What helps large exchanges maintain a sufficient liquidity level is cooperation with market makers (MMs). This article explains their types and the efficiency of automated MMs.

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Types of Crypto Market Makers

A crypto market maker is a financial entity, high-frequency trader, or company that specializes in market making. Here are the types of MMs:

  • Traditional market makers use their capital to actively participate in crypto exchange trading. They continuously set buy and sell orders on trading platforms and profit from the spread (the difference between buy and sell prices). WhiteBIT market maker services are an example of traditional market making.
  • Automated market makers (AMM) belong to the newer type of market makers, acting on a decentralized landscape (DeFi). Unlike traditional market makers, AMMs don’t use order boo to place buy and sell orders in it. Instead, they use smart contracts that create liquidity pools of assets.

How Does Automatic Market-Making Work?

Automatic crypto market-making involves algorithms that provide liquidity by automatically placing buy and sell orders for cryptocurrencies. These algorithms adjust the price of assets based on supply and demand dynamics without needing a traditional buyer-seller matching order book.

Here’s how it works. Imagine an AMM on a DEX with a liquidity pool containing two tokens, A and B. The AMM uses a simple formula, such as x∗y=const, where:

  • x is the amount of token A; 
  • y is the amount of token B in the pool.

Let’s say you want to buy one token B using token A. The AMM calculates the necessary amount of token A to maintain the constant. If there’s a large supply of token A and a smaller supply of token B in the pool, you’ll need to provide more token A to buy token B. Once the trade is fulfilled, the supply of token A in the pool increases, and the supply of token B decreases, automatically adjusting the price for future trades. 

Market makers in crypto, be it traditional or automated, play an essential role in maintaining liquidity and fair prices on crypto trading platforms.

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