If you are a regular DeFi user, you have probably heard about Automated Market Makers (AMMs). AMMs are smart contracts that allow users to trade on DEXs and exchange assets at their desired price. They are a breakthrough innovation that has helped make trading on decentralized exchanges a reality.
However, market making in the DeFi market making world is far from simple. Instead of using smart contracts, market makers may use a variety of strategies to supply liquidity. These include pooling liquidity from various sources and utilizing algorithmic trading. Other options include partnering with an exchange or leveraging their own capital. This enables users to buy and sell assets with minimal effort.
The best way to think of a market maker is as a middleman. Market makers act as the go-between for users and a number of different liquidity pools. In return, they earn a percentage of the trading fees and are rewarded with tokens in the process.
There are a number of market makers who are putting their money where their mouth is. Evgeny Gaevoy and Yuriy Myronovych are a couple of examples of market makers who are at the forefront of the DeFi space. Another market maker to keep an eye out for is dYdX. dYdX CEO Yuriy has spoken a few times about the future of DeFi and has even participated in the governance of the DeFi protocol. He has also provided liquidity to the DeFi protocols.
Among the biggest risks for market makers are technology and operational ones. While an off-chain order book can outcompete an order book-based exchange, a market maker’s reliance on a liquidity pool makes it susceptible to the whims of the centralized order book. Moreover, the average time to liquidate an asset on a centralized exchange can be hours.
One of the most common questions about market making is how to fund the process. Even the largest market makers have limited resources to serve the entire market. This is one reason why many smaller projects benefit from the services of a market maker.
Of course, there are a number of other risks that need to be considered. Some of these include the aforementioned impermanent loss and price arbitrage. Impermanent loss refers to the average loss in value of an asset over a certain period of time. Likewise, price arbitrage is the process of buying an asset on a less expensive exchange and then selling it on an exchange that offers a higher price.
Despite its drawbacks, it can be a lucrative business for some market makers. As a matter of fact, there are several projects in the DeFi space experimenting with different mechanics to boost their market making.
For example, FTX has launched Serum DEX, which is an attempt to integrate a hybrid model of on-chain and off-chain market making. Meanwhile, Kyber has embarked on a project to implement new order matching mechanics. With such a large number of projects and innovations, the DeFi ecosystem is an ever-growing and exciting place to be.
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