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The Role of Automated Market Makers in Crypto Liquidity Provision

●   6 min

Crypto has truly revolutionized the financial landscape, introducing innovative technologies and financial instruments that are highly efficient. Among these innovations, Automated Market Makers (AMMs) have played a pivotal role in reshaping liquidity provision within the crypto market πŸ“ˆ

In this blog, we’ll explore the essential role of AMMs in crypto liquidity provision, their benefits, real-world examples, challenges, and future developments 😎

Ready to get started? πŸ™Œ


Key Takeaways

  • AMMs, powered by smart contracts and algorithms, have transformed how liquidity is provided and traded in the crypto market.
  • Unlike traditional market makers that rely on centralized intermediaries and capital reserves, AMMs operate autonomously and enable direct peer-to-peer trading on decentralized exchanges (DEXs).
  • AMMs enhance liquidity, trading efficiency, and accessibility, making crypto trading more inclusive and efficient. They also reduce reliance on centralized exchanges, improving user control over funds.
  • Prominent AMMs like Uniswap, KyberSwap, PancakeSwap, Curve, and Pendle have demonstrated the versatility and utility of AMM technology in various blockchain ecosystems.
  • Impermanent loss and potential risks, such as smart contract vulnerabilities, underscore the importance of due diligence and risk management for liquidity providers in AMMs.
  • AMMs continue to evolve, with ongoing refinements in design and algorithms to address challenges like impermanent loss. They are also being integrated into the broader DeFi ecosystem for seamless financial activities.

Understanding Automated Market Makers (AMMs)

Before diving into the role of AMMs, it’s crucial to understand their fundamental principles and how they differ from traditional market makers πŸ€”

Traditional market makers are typically centralized entities that facilitate trading by offering buy and sell orders. They rely on significant capital reserves to maintain liquidity πŸ’°

AMMs, on the other hand, operate autonomously through smart contracts and algorithms. They enable users to trade assets directly on blockchain-based decentralized exchanges (DEXs) without relying on intermediaries.

AMMs automatically adjust the price of assets based on the supply and demand within the platform, making trading accessible to a broader range of participants πŸ“ˆ

AMMs primarily use two assets, typically referred to as “liquidity pools,” to facilitate trading pairs. These pools are governed by predetermined mathematical rules encoded in smart contracts. When a trader wants to make a swap, they interact with the AMM’s smart contract, which calculates the exchange rate based on the pool’s current asset balances πŸ’Ή


Benefits of Automated Market Makers

The adoption of AMMs has brought several advantages to the crypto market:

1️⃣ Increased Liquidity and Trading Efficiency: AMMs provide continuous liquidity by allowing users to trade assets 24/7 without waiting for traditional market hours. This increases market efficiency and reduces bid-ask spreads, resulting in better prices for traders πŸ’ͺ

2️⃣ Greater Accessibility: AMMs democratize access to crypto trading by enabling smaller investors to participate without facing the barriers often associated with traditional financial markets. Users can provide liquidity to AMMs and earn fees, levelling the playing field πŸ’ͺ

3️⃣ Lower Reliance on Centralized Exchanges: AMMs promote decentralized trading, reducing reliance on centralized exchanges that can be prone to downtime and regulatory scrutiny. Users have more control over their funds, reducing counter-party risk πŸ™Œ

Case Studies and Examples

Several AMMs have gained prominence in crypto over the past few years. Some of them include:

πŸ¦„Β Uniswap: The OG! Uniswap V3 is a popular AMM protocol that allows users to provide liquidity within customized price ranges through concentrated liquidity, offering greater control and potential fee optimization. LPs on Uniswap V3 can track their positions using tools like Krystal Liquidity Lens, gaining smart insights into their holdings and performance.

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🟒 KyberSwap: KyberSwap is an integral part of the Kyber Network, which provides on-chain liquidity for various DeFi applications. KyberSwap offers a wide range of tokens for trading, allowing users to participate in Kyber’s liquidity program by providing liquidity to token pairs. KyberSwap LPs can effortlessly track and manage their positions using cutting-edge tools like Krystal Liquidity Lens, empowering them with crypto-native analytics and in-depth performance insights.

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πŸ₯žΒ PancakeSwap: Initially launched on the BNB Binance Smart Chain but now available on Ethereum, Arbitrum, Polygon zkEVM and more, PancakeSwap V3 is a popular DEX that provides a wide array of DeFi services, including yield farming and AMM-based trading. Very popular among BNB Degens!

You can also track liquidity providers (LPs) on PancakeSwap V3 through Krystal Liquidity Lens feature available here! Stay updated with the latest LPs data and monitor your LPs with ease.

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🍣 Sushiswap: LPs in SushiSwap are formed by token pairs like ETH/USDT or DAI/USDC. Users can provide an equal value of both tokens to create a balanced liquidity pool. By doing so, they become liquidity providers (LPs) and receive LP tokens in return. These LP tokens represent their ownership in the pool and can be redeemed for their proportionate share of the pooled assets.

LPs in SushiSwap play a vital role in token availability for trading and also earn fees generated by the exchange. Whenever a trade occurs in a liquidity pool, a portion of the trading fees is distributed among the LPs based on their share in the pool.

Now you can track LPs on SushiSwap using the Krystal Liquidity Lens feature, accessible here! Stay in the loop with real-time LPs data and effortlessly monitor your LPs.

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πŸ”΅Β Pendle: Pendle Finance introduces novel yield tokenization and AMM concepts, allowing users to maximize yield generation on their assets. Users can tokenize future yield from their assets, enabling more advanced strategies for yield optimization. This introduces a new dimension to DeFi by allowing users to trade, lend, and borrow future yield streams.

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Challenges and Limitations With AMMs

While AMMs offer numerous benefits, they are not without challenges:

  • πŸ“‰Β Impermanent Loss Variability: Impermanent loss is a key concern for liquidity providers on AMMs. While it’s a temporary loss that may diminish over time, the extent of impermanent loss depends on various factors, including the assets’ price volatility and the specific AMM design. Liquidity providers may find it challenging to accurately predict and manage this loss. We have written a complete guide on it here.
  • πŸ’°Β Limited Fee Generation During Low Volatility: AMMs generate fees from trading activity within their liquidity pools. However, during periods of low volatility or when trading volumes are minimal, the fees earned by liquidity providers can be insufficient to compensate for impermanent loss or operational costs. This can discourage liquidity provision during quieter market phases.
  • ⚠️ Slippage and Front-Running: AMMs can be susceptible to slippage, either through large trades that impact asset prices within the liquidity pool and also based on the size of the pool. So as an LP, keeping an eye on the total pool size is vital. Additionally, front-running by malicious actors can manipulate prices and lead to undesirable trading outcomes. These issues can result in reduced profitability for liquidity providers and erode trust in AMM protocols.

Future Developments of AMMs

The world of AMMs is dynamic, with continuous innovations and developments:

  • βœ…Β Evolution of AMMs: AMMs are continually improving their algorithms to minimize impermanent loss and optimize fee generation. Innovations like concentrated liquidity and dynamic fee structures are being explored πŸ“ˆ
  • βœ…Β More DeFi Integrations: AMMs are increasingly integrated into DeFi platforms, enabling users to participate in yield farming, lending, borrowing, and other DeFi activities pretty seamlessly πŸ’ͺ
  • βœ… Advanced Liquidity Tracking Tools: As AMMs become more intricate, liquidity tracking tools like Krystal’s Liquidity Lens will continue to evolve and will play a crucial role. They provide real-time insights, risk assessment, and optimization suggestions, empowering liquidity providers to make informed decisions in the evolving world of DeFi.


AMMs have emerged as a transformative force in crypto liquidity provision. They have democratized access to trading, increased efficiency, and reduced dependence on centralized exchanges πŸš€

While challenges exist, ongoing innovation and integration with DeFi suggest a promising future for AMMs. As the crypto market continues to evolve, AMMs will likely play a pivotal role in shaping the broader financial landscape, ushering in a new era of decentralized finance πŸ”₯

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