- Automated market makers (AMMs) and order books represent distinct trading systems in the cryptocurrency market, each with advantages and drawbacks.
- The suitability of either system depends on individual traders’ specific requirements and preferences.
- The cryptocurrency trading market is projected to attain a global market size of $2.2 Trillion by 2028.
Since the dawn of writing, order books have been a cornerstone of commercial transactions. Even 4,000 years ago, Mesopotamian merchants relied on them to manage their goods, sales, and finances.
In stark contrast, the advent of DeFi in recent years marks a significant departure from traditional practices. Decentralized Exchanges (DEXs) enable transactions worth billions of dollars through nothing but lines of code.
This innovation is embodied by the Automated Market Maker (AMM) model.
AMMs have revolutionized the DeFi landscape, enabling anyone with an internet connection to trade cryptocurrencies without restrictions, KYC (Know Your Customer) requirements, or lightning-fast settlements.
However, centralized exchanges (CEXs) maintain their importance by offering user-friendly interfaces and professional trading tools, characteristics synonymous with order book-based trading.
While decentralized trading has gained immense popularity, it remains a distinct process from conventional exchange order books.
Let’s get started
Automated Market Makers (AMM) vs. Order Books: What’s The Difference?
Automated Market Makers (AMMs) and Order Books are two fundamental trading mechanisms in the cryptocurrency field.
This article comprehensively compares these two approaches to help one understand their differences and advantages.
- Functionality
AMMs: AMMs are decentralized algorithms that enable users to trade assets directly on blockchain platforms. They use liquidity pools and smart contracts to determine prices based on supply and demand.
Order Books: On the other hand, Order Books rely on traditional trading concepts. They match buyers and sellers based on their submitted orders, creating a visible list of bid and ask prices.
- Liquidity
AMMs: AMMs typically have higher liquidity for less commonly traded tokens because liquidity providers contribute assets to pools, ensuring continuous trading.
Order Books: Order Books tend to have higher liquidity for popular assets as they depend on active traders placing orders.
- Complexity
AMMs: AMMs are simpler for novice users since they don’t require setting specific prices; users only need to decide how much they want to trade.
Order Books: Order Books can be more complex for beginners due to the need to understand various order types (market, limit, stop-loss, etc.) and price dynamics.
- Price Discovery
AMMs: AMMs use an algorithmic approach to calculate prices based on the ratio of assets in the liquidity pool. Price slippage can occur when trading larger amounts.
Order Books: Order Books offer better price discovery for large trades, allowing users to specify the price they want to buy or sell.
- Transparency
AMMs: AMMs provide transparent pricing as the algorithmic rules are predefined and visible on the blockchain.
Order Books: Order Books offer transparency by displaying all pending orders, allowing traders to gauge market sentiment.
- Execution Speed
AMMs: AMMs execute trades instantly since they match orders with predefined liquidity pools.
Order Books: Order Book trades can be executed quickly, but it depends on finding a matching order.
- Slippage
AMMs: Due to their algorithmic pricing, AMMs can experience more slippage, especially for large trades.
Order Books: Order Books allow traders to avoid slippage by specifying the price they are willing to accept.
- Flexibility
AMMs: AMMs are more suitable for smaller trades and users who prioritize simplicity and liquidity.
Order Books: Order Books offer flexibility for small and large traders who want more control over their trades.
Conclusion
These two ways of creating exchanges have distinct advantages and downsides. Order book exchanges dominate the market for larger cryptocurrencies such as Bitcoin and Ethereum. AMMs, on the other hand, assist consumers in acquiring the best price for coins with limited liquidity.
Furthermore, AMMs have enabled LPs to leverage existing liquidity holdings to achieve even greater capital efficiency, which is a substantial benefit.
