You might be wondering what is an automated market maker?
Well automated market maker allows traders to buy and sell certain coins using an algorithm
that dictates how expensive something should be based on how much of it there is.
As someone buys one asset, it gets more and more expensive because there's less of it.
And as they give it another asset, it gets cheaper and cheaper.
because there's more of it.
Basically, it's supply and demand, but it's using an algorithm instead of the traditional method which uses a person.
Welcome to Whiteboard Crypto, where we explain cryptocurrency topics using analogies, stories, and examples so that you can actually understand them.
And in this video, we're going to cover what an automated market maker is and exactly how it works.
Let's dig in.
Let's say that you're a potato farmer.
You're sick and tired of going to work and seeing potatoes everywhere.
Then home to eat only more potatoes, even though you can cook some potatoes in very interesting ways.
You do not want any more potatoes.
But here's a real kicker though.
You live in a village of potato farmers, so you can't really try.
your potatoes for anything else.
It would be nice to trade my potatoes for something else like apples, you think.
Well, along comes a trader who has access to a boat and he says, I found a village over east who grows apples and they are sick of them.
I am here to see if you would like to invest in a trade.
Well, now that your wish has come true and you don't want the chance to disappear.
you tell the trader yes.
He says the apple farmers have put up 50,000 apples to add to my apple potato exchange business.
If you can give me 50,000 potatoes, we can get started.
So your village has a meeting and they decide to join the trader in exchanging apples and potatoes.
The trader goes here's the thing though.
I have imagined genie with me that will store all 50,000 apples and all 50,000 potatoes in his magical lamp to keep safe.
That they don't go bad, but he wants to keep a perfect ratio of the value of both of these.
The trader goes on,
since together we put in 50,000 apples and 50,000 potatoes,
he wants both of these numbers to always multiply to equal 2.5 billion, which is equal to 50,000 times 50,000.
This way, if one year there are less apples, the apples will cost more to buy.
If you're currently confused at what the magical genie has mentioned,
it is actually the formula for a type of automated market maker called a constant product.
market maker.
It uses the inverse formula x times y equals k.
Well and y are the quantities,
or the amounts of the things that you have, where k is a constant that always stays the same and it does not change.
In this case, k is 2.5 billion.
Let's keep going on with an example so that maybe you can understand it just a bit.
bit better.
apples and 50,000 potatoes.
And the number of both of those must equal 2.5 billion when multiplied.
So let's say a potato farmer comes along with 7,000 potatoes to trade because they really want some apples.
So he gives them to the genie and he waits while the genie figures out how many apples to give him.
So now we have 57,000 potatoes.
in the genies lamp, but we need to know how many apples to give the potato farmer.
So start with some math.
So we take 2.5 billion and we divide it by 57,000.
You might be wondering why?
Well, hopefully you'll see in a second.
The answer we get to this math question is 43,859.
So this is the number of apples that should be left over in the magical genies lamp.
However, right now there's 50,000, so we just need to find out the difference and give the difference to the potato farmer.
Well difference is 6,140, so we give the potato farmer 6,140 apples.
Now you might be wondering, how come we gave 7,000 potatoes, but we got around 6,000 apples?
Well, as more and more apples were bought up, they became more expensive.
This is why the farmer didn't get exactly 7,000 apples back.
So there are 57,000 potatoes and 43,859 apples in the genie's lamp.
Let's make sure that we didn't upset the genie.
57,000 times 43,859 does equal 2.5 billion, so the genie is still happy.
I hope that this is starting to make sense,
and if you've gotten this far into my explanation of how an automated market maker happens,
without even using any technical words, I think we deserve a big thumbs up.
But before we continue with another example, let's run over a quick example of finding out how much each asset costs and $1.
So, assume that there was $50,000.
were the vapples in the beginning since the magical genie said he priced them at $1 and there was 50,000 of them.
So just need to keep $50,000 as a constant when we're calculating their value.
This is how much each asset should equal.
So potatoes would be $50,000 over $57,000 because that's how many potatoes we have, which brings their price to $87,000.
point seven pennies for each potato.
You might be wondering, why did they drop from a dollar?
Well, it's because someone brought a lot more of them to the genie.
It's basic supply and demand.
For example,
if you could grow gold on trees in your backyard, gold would suddenly be a lot cheaper because there's a lot more of it.
The more there is in the genie's lamp, the less they will cost.
So from now on instead of saying genie's lamp.
I'm going to call it what it really is a liquidity pool So now let's calculate the price of the apples this calculation would be $50,000 over
43,859 this means the apples are worth a dollar and 14 cents
They rose in price because there's less of them in the liquidity pool So,
since this potato trader gave a bunch of potatoes to the liquidity pool and took out a of apples,
the price of apples went up and the price of potatoes went down,
basically due to supply in demand, which shown in the formula x times y equals k.
Now, I personally learned from examples, and this concept took me a week of studying the fully understand.
So let's go over another example.
Let's say a potato farmer brings up another 10,000 potatoes.
So now there are 67,000 potatoes in the pool.
We need to know how many apples to give that potato farmer.
So we use our constant of 2.5 billion divided by 67,000 and we get 37,300.
This means that there should be 37,313 apples in the pool, but right now we have 43,859.
So we just calculate the difference and give it to the potato farmer, which is 6,546.
This time the potato farmer paid even more for his apples since he kept buying them up.
pool charges more and more for them, that way it never runs out of stock.
The will exponentially keep going up as he buys more.
So now there are 67,000 potatoes and 37,313 apples in our liquidity pool.
Both of these numbers multiply to 2.5 billion.
So the genie, which is actually the algorithm, is happy.
Let's calculate the price.
$50,000 divided by 67,000 potatoes means the potatoes are worth 74.6 pennies.
They even lower.
Next, $50,000 divided by 37,313 apples means the apples are now worth $1.34 cents.
They rose in price.
So again, we saw that there were more potatoes than before.
So the price dropped and there were less apples than before so the price rose now
Hopefully you are understanding how an automated market maker works as someone buys more and more of something the price goes up
The apples are costing more because there's less of them and when it comes to pricing the algorithm always wants the value of what it is
Holding to be 50 50 so if you multiply the price of each asset by how many assets were total in the liquidity pool,
the total would still be $50,000 worth of apples and $50,000 worth of potatoes.
Let's do one more example really quick just to drive at home.
This time an apple farmer comes along with 2,000 apples, so he adds them to the liquidity pool and now there are $39,313.
apples, but we need to figure out how many potatoes to give him.
If you want to, you can pause this video and try to come up with a number on your own.
Just for fun, leave a comment of what you come up with in the comment section below.
So finishing the math 2.5 billion divided by 39,313 gives us 63,592, which is how many potatoes there's.
should be in the pool.
Well now there's still 67,000 potatoes and the pool only wants 63,592.
So we take the difference and we give it to the apple farmer which is 3,408 potatoes.
So in essence the farmer gave 2,000 apples and got 3,408 potatoes because at the time he his apples were very valuable.
Now we went over those examples really quick and feel free to go back to the beginning of this video and watch it again.
And if you're still kind of confused, I highly recommend watching our video on liquidity pools and how they work.
But one thing I want you to know is that a real liquidity pool can sometimes have up to millions of dollars'
worth of assets in it.
And, you should know, the more money that is in a liquidity pool, the stapler, the prices.
If there were half a million apples and half a million potatoes,
and you still only wanted to trade around 2,000 apples, the price difference wouldn't change as much as we saw in our example.
Because the amount of apples you were trading, in proportion to the amount of apples in the pool, was a very small amount.
Now also,
you should know that liquidity pools reward investors and the investors are the people who put up the money into the liquidity pool in the first place.
They give those investors a small fraction of each trade that happens on their platform.
Now even if this is less than 1% of each trade, if someone is trading multiple times a day, those numbers really add up.
it can be profitable for the investor.
Another thing to know about liquidity pools is that they can get really complicated really fast.
Because what if another trader came along and wanted to add another 50,000 apples and 50,000 potatoes from the villages that he found?
How do we make sure that the investors can take out their original investment as the price is changing?
What about if we find a pineapple?
former and we want to add him to the trading pool well there are answers to these questions
but therefore a different video as this one has came to its end we try to keep these videos
short and very simple to understand so if you want to learn more consider subscribing to
watch our future videos or checking the playlist in the description for similar topics thank
you guys so much for watching we I that you learned something and we hope to see you in the next video.
