Automated Market Maker(AMM) is not new to cyrptocurrency, especially in the Decentralized Finance sector (Defi). It is made use of by Decentralized Exchanges (Dex) in its operations. However, the concept is still relatively new into NFTs, a lot of products have come up to help create this adoption, such as UniclyNFT, bridgesplit , Frakt, NFTx, Solvent Protocol, Tensorswap etc. These automated markets for NFTs were created to help provide liquidity for traders.
While they may have been successful when it comes to operation, a large number of NFT traders do not make use of them, some do not even know that such applications or operations exit, these traders are very unlikely to be the case with Defi that are very familiar with the concept.
Subsequently, there was a new AMM introduced to NFT on the Ethereum Blockchain, Sudoswap, while Sudoswap still lags behind the leading Ethereum NFT marketplace, Opensea, reports showing that there has been a notable use of Sudoswap by Ethereum NFT traders worthy of recognition. This probably led to similar innovations on other famous NFT blockchains like Solana, this includes the recently launched, Hadeswap, and already in plan AMM, Elixir.
If you have ever made use of Decentralized Exchanges like, Uniswap, Curve, Pancakeswap or Raydium, you have traded on an Automated Market Maker. If you have never done that, do not fret, AMM is simply trading in a market that allows for only one party is involved in a transaction.
Unlike Centralized exchanges (Cex), like Binance, Coinbase, etc, where there are transactions carried out peer-to-peer requiring an additional party like in a normal traditional market, in an AMM, the only interaction by the trader is with the smart contracts which enables the transaction to take place.
There is a need for liquidity to be provided to a trader exchanging assets or tokens in an AMM, liquidity pools are made use of to represent the role of the other party that provides liquidity as an exchange for the tokens as used in human or centralized markets.
Liquidity pool is the provision or supply of funds by people known as liquidity provider to enable enough liquidity for AMM trades. These direction providers earn fees from every trade that makes use of the pool, the exact percentage is determined by the AMM. The already in place liquidity provided for you in any Dex making use of AMM is as a result of the pool getting from funds of liquidity providers. Since the liquidity is already available, it completely removes the need of an extra party to provide liquidity as the role of such party has been assumed.
In the absence of another party to determine how much the tokens or assets should be priced or exchanged, Automated market maker makes use of mathematical formulars to determine prices. The formular may vary with different AMM, for example uniswap uses x*y =k.
For trading to occur on an AMM, there has to be a pair, this means exchanging or trading one asset for the other, for example ETH/DAI or SOL/DUST. x is the amount of one token in the pair, and y is the amount of the other token in the pair and k is a fixed constant. The fixed constant (k) is the pool’s total liquidity which should remain the same.
NFTs are unique tokens which represent assets, digital or virtual, the idea has always been that trading of NFTs can only be done by two parties just like how physical assets are traded. Marketplaces have been created to aid these transactions among both parties, the seller and the buyer.
These marketplaces are custodial, upon the transaction of an NFT, the NFT leaves the wallet of the seller to the marketplace until a buyer purchases it. This temporary possession of the NFTs by the marketplace places gives them full authority over the NFTs which may be exercised to the dislike of the asset owners. Centralization and undue human interference were the reasons why AMMs were initially created.
This brought about the innovation of AMMs for trading NFTs, where NFT owners do not only have full custody of their NFTs till the transaction is over, but also can trade NFTs without a buyer. Automated Market Makers for NFT trading also make use of liquidity pool sourced from funds provided by liquidity providers. This eliminates the need of another party such as buyer or seller, since liquidity is already available.
Also, it was noticed that liquidity was low in NFTs, probably due to low volume or hypo on a particular NFT. However, there is a need for liquidity in the system and in the hands of traders to create a more efficient and performing market. Hence, the creation of an Automated Market where traders do not need to wait for a seller to be interested in their assets to get liquidity in return, they could simply trade it against the liquidity pool available.
Sellers or buyers of NFT simply need to just connect their wallet, search for the NFT they would like to sell or purchase and trade it against any other token or currency of their choice provided there is a liquidity pool for it on the marketplace. NFTs could also be exchanged for one another instead of for liquidity on an AMM.
AMMs may be creating a very efficient trading platform for traders in centralized markets where a seller has to list NFTs one after the other. In an AMM, a seller can create a list order to list all NFTs of one’s wish at a certain price or varied price. Upon listing of the NFTs, a seller could input a certain percentage increase of the price of the listed NFTs upon the sale of one NFT.
For example a seller lists 10 NFTs for 1 ETH at a 10 percent increase price, upon the sale of the first one, the next NFT’s price becomes 1.1ETH and accordingly. This way one can maximally and efficienly exit an NFT, instead of constantly checking floor prices on centralized marketplaces and adjusting listing price.
This is also similar in the case a buyer, one can effectively buy NFTs as the price reduces once you already input the range or percentage of your choice. This way you will be able to effectively accumulate NFTs at a better price. For example, a buyer inputs a 10% decrease when buying 10 NFTs at 1E, after buying the first one, the price of the next becomes 0.9E and the reduction continues accordingly until the purchase of the final NFT.
It should be noted that to take part in this buying and selling, the complete amount that would be made use of in the transaction should already be deposited.
While this is a laudable innovation that further allows trading to be more seamless, and more importantly more decentralized, there are still some risks associated with trading NFTs in an AMM.
Being a recent innovation, liquidity pool may not hold enough liquid for the volume of NFTs trading everyday. An average volume of NFTs trading in Opensea and Magic Eden daily is consecutively. It may take some time to get liquidity providers to fund the pool as much as that, pending that time, trading NFTs may be slow and could result in slippage and traders can lose money as a result of that.
Not all AMMs support all kind of NFTs, an attempt to try to trade an unsupported NFT on a particular automated market may lead to loss of funds from such trader. Some AMMs charge more fees than others, the ignorance of this by a trader may also lead to a loss of funds.
Automated Market Maker in Defi has become really popular amongst DeFi traders, whereas in the case of NFTs centralized markets are the order of the day, with some being extremely dominant. Whether traders would fully adjust to AMMs instead of centralized market cannot be ascertained yet, as some NFT traders have never even used DeFi protocols.
Regardless, it is a very good innovation and would allow for more effective trading, more liquidity and as a result bring in more people into NFTs. Asides that, it leaves the community with a choice to decide if they would rather trade their assets with another party, or exchange it on a liquidity pool which is the essence of web 3.Web 3 was initiated to give the community the power to decide and make choices by themselves.
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