2 Ways Cryptocurrency Exchanges Transfer Funds: Order Books vs AMMs

2 Ways Cryptocurrency Exchanges Transfer Funds: Order Books vs AMMs


Learn about the two primary ways to transfer on crypto exchanges, including order books and automated market makers (AMMs), and how they differ in this informative CoinDesk article.

Cryptocurrency exchanges have order books just like the NYSE, but the digital investment realm likewise offers something very different known as automated market makers (AMMs).

The con­cep­tu­al sim­plic­i­ty of dig­i­tal cur­ren­cies dri­ves much of the excite­ment and adop­tion of the invest­ment class. Dig­i­tal cur­ren­cies are, by and large:

  • dig­i­tal units of account …
  • that store val­ue …
  • and that can be exchanged for oth­er items of val­ue.
  • Read­ers who can still recall their ear­ly prin­ci­ples of eco­nom­ics class­es prob­a­bly rec­og­nize that those 3 tenets are part of the def­i­n­i­tion of mon­ey itself.

    Still, con­cep­tu­al sim­plic­i­ty gives way rapid­ly to prac­ti­cal com­plex­i­ty when users look clos­er at cryp­tocur­ren­cy. That’s espe­cial­ly appar­ent with its use as a medi­um of exchange, point #3 over. And like­wise often in the case of trans­fer­ring cryp­tocur­ren­cy from one par­ty to anoth­er.

    In cryp­tocur­ren­cy, unlike con­ven­tion­al finance, there are two very dif­fer­ent kinds of exchanges. And help­ing you grasp them – just like any thorny top­ic in cryp­tocur­ren­cy – is a chal­lenge I rel­ish tak­ing on.

    There are two pri­ma­ry ways to trans­fer on cryp­tocur­ren­cy exchanges:

  • Order books
  • Auto­mat­ed mar­ket mak­ers (AMMs)
  • Order books are most com­mon, and they’re like­wise the most rec­og­niz­able for any­one com­ing from a tra­di­tion­al finance back­ground. This is just like how the New York Stock Exchange, Nas­daq and oth­er con­ven­tion­al mar­ket­places assem­ble buy and sell orders in a pub­lic place so new orders can get matched up with them.

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    In cryp­tocur­ren­cy, this is how Binance Cryp­to exchange and oth­er cen­tral­ized exchanges work. Binance Cryp­to exchange, with approx­i­mate­ly half of cryp­tocur­ren­cy exchange vol­ume, is the largest one.

    In the order book realm, traders was known mar­ket mak­ers help keep busi­ness churn­ing by buy­ing from any sell­er and sell­ing to any buy­er, col­lect­ing the spread betwixt bid and ask prices as their reward – some­thing that can be quite prof­itable if done over and over. ( Past week, I talked about cryp­tocur­ren­cy high-fre­quen­cy traders, cor­po­ra­tions that pro­vide this ser­vice.)

    1 of the advan­tages of order books is they allow every­one to see mar­ket depth, i.e. the extent to which orders are con­cen­trat­ed around spe­cif­ic price points. Traders can gain insight into mar­ket direc­tion by study­ing mar­ket depth and mak­ing sub­se­quent deci­sions – a rea­son why order books are pop­u­lar.

    On the oth­er hand, cryp­tocur­ren­cy has its own unique way of trans­fer­ring mon­ey from buy­ers to sell­ers, known as auto­mat­ed mar­ket mak­ers. (The name sounds like the traders – mar­ket mak­ers – men­tioned ear­li­er who prowl order books, but these are very dif­fer­ent things.)

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    Where order books are preva­lent across cen­tral­ized exchanges (CEXs), AMMs are preva­lent in decen­tral­ized exchanges (DEXs). Uniswap is a notable DEX.

    Where order books rep­re­sent a peer-to-peer arrange­ment under­pinned by the match­ing of buy­ers and sell­ers, AMMs rep­re­sent a peer-to-con­tract rela­tion­ship under­pinned by pools of liq­uid­i­ty.

    Liq­uid­i­ty pools are col­lec­tions of cryp­to tokens that have been sup­plied by liq­uid­i­ty providers. Liq­uid­i­ty providers are users who decide to deposit their own assets into a pool, incen­tivized to do so by the receipt of some­thing of val­ue.

    Users deposit coins into a liq­uid­i­ty pool. Oth­er users who wish to buy or sell inter­act with pools hold­ing the invest­ment they’re inter­est­ed in, trad­ing against the pool itself instead of anoth­er user. Depos­i­tors are reward­ed for sup­ply­ing liq­uid­i­ty.

    Often­times, that comes via the receipt of trad­ing charges or gov­er­nance cryp­to tokens. A com­mon term you will  hear spe­cif­ic to AMMs is “yield farm­ing,” where users deposit cryp­to tokens into liq­uid­i­ty pools while search­ing for the great­est ben­e­fit.

    The method of incen­tiviz­ing users to deposit coins can have a net­work effect, where­by the pools of coins grow, increas­ing liq­uid­i­ty itself.

    Prices of the cryp­to tokens are deter­mined algo­rith­mi­cal­ly, and often tied to the avail­able quan­ti­ties of each invest­ment. For instance a par­tic­u­lar pool may hold $1 Mil­lion worth of Ethereum (ETH) and $1 Mil­lion of USDC – an ETH/USDC pool). Increased demand for Ethereum (ETH) rep­re­sent­ed by increased buy­ing leads to a high­er price for Ethereum (ETH), deter­mined by math­e­mat­i­cal for­mu­la.

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    With DEXs, there is a unique ele­gance borne out of that equa­tion. When it comes to Uniswap, the result is approx­i­mate­ly $500 Mil­lion in vol­ume of dai­ly trad­ing. For con­text, this pales in com­par­i­son to Binance Cryp­to exchange vol­ume of trad­ing, esti­mat­ed to be as high as $4 Bil­lion dai­ly.

    Still DEXs pro­vide a valu­able offer­ing, par­tic­u­lar­ly as it relates to tra­di­tion­al­ly less liq­uid coins. And while CEXs and DEXs are under­pinned by dif­fer­ent things, the inter­sec­tion of finan­cial resources, effi­cien­cy and incen­tives under­pins them all.

    And our goal at Coin­Desk is to pro­vide as much clar­i­ty as we can in explor­ing how they evolve.

    Takeaways

    From Coin­Desk Deputy Edi­tor-in-Chief Nick Bak­er, here’s some news worth read­ing:

    • BITCOIN’S Non-Fun­gi­ble Token (NFT) BOOM: The Ordi­nals pro­to­col has sig­nif­i­cant­ly shak­en up the peck­ing order in Non-Fun­gi­ble Token (NFTs), turn­ing good old Bit­coin (BTC) – shock­ing­ly – into a major play­er. In just sev­er­al  months, Bit­coin (BTC) has gone from a tie for last place in Non-Fun­gi­ble Token (NFTs) to the num­ber two blockchain tech for Non-Fun­gi­ble Token (NFT) sales. Ethereum (ETH) remains in first, which makes sense giv­en its use of smart con­tracts; this was an eco­log­i­cal sys­tem built for this kind of thing. On the oth­er hand, inscrib­ing Non-Fun­gi­ble Token (NFTs) into Bit­coin (BTC) was not an obvi­ous use case for the orig­i­nal blockchain tech. And is still, here we are.
    • A FRENCH WELCOME: It’s got­ten hard to be a cryp­tocur­ren­cy com­pa­ny in the Unit­ed States in 2023, with reg­u­la­to­ry author­i­ties tak­ing tan­gi­ble steps to increase scruti­ny of the indus­try, and the loom­ing threat of more action as politi­cians amp up anti- cryp­tocur­ren­cy rhetoric. Just this com­ing week amid the debt-ceil­ing show­down, Pres­i­dent Joe Biden stat­ed he wouldn’t accept a deal that “pro­tects wealthy tax cheats and cryp­tocur­ren­cy traders.” And, it should come as no sur­prise that oth­er coun­tries can poten­tial­ly try to lure Amer­i­can cor­po­ra­tions to their friend­lier shores. Take France, for instance. “If Amer­i­can play­ers want to ben­e­fit, in the very short term, from the French regime, and from the start of 2025 from Euro­pean arrange­ments, clear­ly they are wel­come,” Benoît de Juvi­gny, Sec­re­tary Gen­er­al of the Autorité des marchés financiers (AMF), informed reporters Tues­day.
    • CANADA, TOO: Coin­base Cryp­to exchange, the large U.S.-based cryp­tocur­ren­cy exchange, recent­ly inti­mat­ed it could move over­seas if the reg­u­la­to­ry envi­ron­ment per­sists to be, from its per­spec­tive, less than ide­al. In a sub­se­quent inter­view with Coin­Desk, a senior Coin­base Cryp­to exchange exec­u­tive stat­ed the com­pa­ny likes Canada’s approach, some­thing he was known “reg­u­la­tion by engage­ment,” as opposed to the “reg­u­la­tion by enforce­ment” scheme else­where. Makes you won­der if Coin­base Cryp­to exchange can poten­tial­ly con­sid­er head­ing north.
    • A LONG READ: Coin­Desk jour­nal­ists did an in-depth analy­sis of a cryp­tocur­ren­cy min­ing facil­i­ty was known Greenidge Gen­er­a­tion in upstate New York. They did excel­lent on-the-ground report­ing – some­thing no one else appears to have done – to debunk mis­in­for­ma­tion in the debate over whether min­ing should be per­mit­ted or not on envi­ron­men­tal grounds. It’s well worth your read.
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    Nick Bak­er.

    Source

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