<p><strong>AMMs (Automated Market Makers)</strong> have ruled the current DeFi landscape, with over 300 projects forking the Uniswap code and countless more implementing their own version of the unique AMM. The vast bulk of on-chain spot trading activity is still conducted on AMMs. There are also more token pairings on AMMs than on centralized exchanges. However, a new (and, in some cases, old) narrative is developing. This is particularly true in the Cosmos ecology. With the introduction of order book-specific blockchains such as Sei, Injective, Kujira, and dYdX to Cosmos, there is growing concern about the reigning position of AMMs and how they will coexist with <strong>Central Limit Order Books (CLOBs).</strong></p><h2>What is an Automated Market Maker?</h2><p dir="ltr"><strong>An </strong><a href="https://www.builder.news/crypto-insights/an-ultimate-guide-on-automated-market-makers-PvtRU" alt="An ultimate guide on Automated Market Makers" title="An ultimate guide on Automated Market Makers" target="_blank" rel="" class=""><strong>Automated Market Maker</strong></a><strong> (AMM)</strong> is a collection of smart contracts that allows tokens to be exchanged, with market values determined by the relative balance of assets in "liquidity pools." In the case of constant product AMMs, the price of one token compared to another is computed using a constant product formula and the proportion of each type of token in the pool. When a customer deposits tokens into a constant product pair, their liquidity is dispersed over all potential price curves ranging from zero to infinity. When a user swaps tokens and adds/removes tokens from a pool, the proportion between the two tokens is recalculated, and the price adjusts based on its current position in the curve. Liquidity in stable swap AMMs is still dispersed throughout all potential price ranges, although it tends to cluster more tightly around the 1:1 swap rate.</p><p dir="ltr">Arbitrageurs are also important in price discovery. If an asset is priced higher on a centralized exchange, the user might purchase it from the AMM and sell it on the CEX. However, if the asset is priced lower in a CEX, a user might purchase it and sell it to the AMM. In either instance, the pool's token distribution is recalibrated until the AMMs price matches the external pricing circumstances.</p><h2>What is a Central Limit Order Book?</h2><p class="prosemirror-p-center"><img src="https://cdn.builder.news/news/11ed40a2d57cc455a8e6023f659fee92.jpg" alt="Central Limit Order Book" title="Central Limit Order Book" width="600" height="338" class="lykafe0"></p><p dir="ltr">A <strong>Central Limit Order Book (CLOB)</strong> is a type of exchange architecture that collects limit orders and connects buyers and sellers. Although CLOBs are fresh to DeFi, they have existed for decades in traditional finance. They are also widely utilized in centralized crypto exchanges. The scarcity of on-chain CLOBs is primarily due to the fact that they require significantly more transactions than AMMs, making tempo and cost a critical factor that has hampered the growth of CLOBs as DEXs.</p><p dir="ltr">CLOBs utilize a different strategy to price discovery than AMMs. Instead of determining the price based on the ratio of tokens in a liquidity pool, the lowest ask price (sell order) on an order book is used. The more limit orders from market users on both sides of the book a pair have, the more liquidity there is. This frequently results in narrower spreads between the ask and bid prices, resulting in more effective trading at certain price levels.</p><h2>A quick comparison between AMM and CLOB</h2><table><tbody><tr><td data-colwidth="184" style="background-color: #f9cf2e;"><p class="prosemirror-p-center"><strong>Criteria</strong></p></td><td data-colwidth="173" style="background-color: #f9cf2e;"><p class="prosemirror-p-center"><strong>AMMs</strong></p></td><td data-colwidth="238" style="background-color: #f9cf2e;"><p class="prosemirror-p-center"><strong>CLOBs</strong></p></td></tr><tr><td data-colwidth="184" style="background-color: [object Object];"><p>Market price</p></td><td data-colwidth="173"><p>Determined by liquidity pools</p></td><td data-colwidth="238"><p>Determined by the lowest asking price</p></td></tr><tr><td data-colwidth="184" style="background-color: [object Object];"><p>Limit orders</p></td><td data-colwidth="173" style="background-color: [object Object];"><p>Mostly no</p></td><td data-colwidth="238" style="background-color: [object Object];"><p>Yes</p></td></tr><tr><td data-colwidth="184" style="background-color: [object Object];"><p>Capital efficiency</p></td><td data-colwidth="173" style="background-color: [object Object];"><p>Mostly no</p></td><td data-colwidth="238" style="background-color: [object Object];"><p>Yes</p></td></tr><tr><td data-colwidth="184" style="background-color: [object Object];"><p>Impermanent loss</p></td><td data-colwidth="173" style="background-color: [object Object];"><p>Yes</p></td><td data-colwidth="238" style="background-color: [object Object];"><p>No</p></td></tr><tr><td data-colwidth="184" style="background-color: [object Object];"><p>Price discovery at all ranges</p></td><td data-colwidth="173" style="background-color: [object Object];"><p>Yes</p></td><td data-colwidth="238" style="background-color: [object Object];"><p>No</p></td></tr><tr><td data-colwidth="184" style="background-color: [object Object];"><p>Easy to become a marker maker</p></td><td data-colwidth="173" style="background-color: [object Object];"><p>Yes</p></td><td data-colwidth="238" style="background-color: [object Object];"><p>No</p></td></tr><tr><td data-colwidth="184" style="background-color: [object Object];"><p>Easy to bootstrap liquidity for a par</p></td><td data-colwidth="173" style="background-color: [object Object];"><p>Yes</p></td><td data-colwidth="238" style="background-color: [object Object];"><p>No</p></td></tr><tr><td data-colwidth="184" style="background-color: [object Object];"><p>Good for type of assets</p></td><td data-colwidth="173" style="background-color: [object Object];"><p>Long-tail assets</p></td><td data-colwidth="238" style="background-color: [object Object];"><p>Fat-tail assets</p></td></tr><tr><td data-colwidth="184" style="background-color: [object Object];"><p>Yield comes from</p></td><td data-colwidth="173" style="background-color: [object Object];"><p>LP incentives</p></td><td data-colwidth="238" style="background-color: [object Object];"><p>Maker reward</p></td></tr><tr><td data-colwidth="184" style="background-color: [object Object];"><p>MEV attacks</p></td><td data-colwidth="173" style="background-color: [object Object];"><p>Yes</p></td><td data-colwidth="238" style="background-color: [object Object];"><p>Yes</p></td></tr></tbody></table><h2>A detailed comparison&nbsp;between AMM and CLOB</h2><p dir="ltr">Now let’s take a closer look at&nbsp;AMM and CLOB to deeply dive into them</p><h3>Capital efficiency</h3><p dir="ltr">Given the disparities in market pricing design, the consequences for capital efficiency are significant. Even though pricing in constant-product AMMs is defined throughout an endless curve, capital is not necessarily utilized in all ranges. A constant product formula, on the other hand, is designed to distribute capital even in such extreme scenarios. Furthermore, if the AMM does not earn enough revenue, positions may experience temporary loss.</p><p dir="ltr">On the other hand, limit orders make up CLOBs. The "liquidity" in a CLOB is made up of buy and sell limit orders that are placed on an order book. Price can focus on certain ranges since limit orders are flexible. The spread is small and the pair is more liquid as ask and bid orders become closer to one another. When buy and sell orders coincide, the CLOB may carry out the transaction with little to no slippage. Due to this, "fat-tail" assets like Bitcoin and Ethereum are perfect for using CLOBs. However, spreads increase and there are sometimes insufficient limit orders on the book to settle trades when liquidity is low. Because of this, AMMs' flexible price discovery is perfect for long-tail assets.</p><p dir="ltr">However, since Uniswap v3 included concentrated liquidity, liquidity suppliers can now define a price range. Using the USDC/USDT pair as an illustration, a user might supply liquidity and define a price range between $0.99 and $1.01. Even while the user would continue to earn fees from transactions in a standard AMM, not all of the user's cash would be invested at those levels. Contrarily, focused liquidity increases the efficiency of the user's money by assigning 100% of it to the defined price range and increasing the potential trading fees.</p><p dir="ltr">Furthermore, concentrated liquidity-based AMMs, in contrast to CLOBs, are just collections of constant product curves, allowing us to maintain the versatility of indefinite price discovery for challenging and volatile edge situations. It would be advantageous to switch out of your assets in the event of the LUNA/UST collapse, for instance, as you wouldn't have to be concerned about your trade being fulfilled.</p><h3>Market making</h3><p dir="ltr">The democratization of market making is arguably one of the most significant contributions made by AMMs. The name implies that market making "automates." Why does this matter?</p><p dir="ltr">Simply by adding liquidity to a pool, a user can spread their assets throughout either an unbounded price range (constant product) or a predetermined price range (in the case of concentrated liquidity). As a result, the typical user may bootstrap a pair incredibly easily and effectively. AMM UIs frequently offer the ability to start a pool entirely without writing any code.</p><p dir="ltr">On the other hand, market creation for CLOBs is quite complex and demands active involvement. A user would have to consider the volume to deposit at each level in addition to creating multiple limit orders on both sides of the order book. Because of this, market making for CLOBs has primarily been reserved for specialized market makers, institutional participants, centralized parties, experienced traders, and others.</p><p dir="ltr">Concentrated liquidity, of course, also calls for involvement. Some claim that concentrated liquidity taken to its logical limit can even resemble a CLOB. In a manner akin to an order book, this would entail distributing numerous LP holdings of varied sizes throughout the price curve. However, such an extreme form is not required for the typical user to take advantage of concentrated liquidity's capital efficiency and become a market maker.</p><h3>Incentives</h3><p dir="ltr">The incentive structure between the two models is another distinction. AMMs rely on swap fees and liquidity pool incentives. Fewer users are prepared to deposit liquidity if exchange payments are insufficient to offset the <a href="https://www.builder.news/crypto-insights/impermanent-loss" alt="Impermanent loss - Sounds familiar but odd?" title="Impermanent loss - Sounds familiar but odd?" target="_blank" rel="" class="">impermanent loss</a>. This leads to increased slippage and decreased trading, which has a snowball effect. Incentives are utilized to draw liquidity because of this. If the trading volume or incentive fees are larger than impermanent losses, this draws more LPs, which improves slippage and boosts trading, increasing fees in a virtuous loop.</p><p dir="ltr">To ensure that the proper balance of incentives is established when it comes to AMM and tokenomics design, several different elements must be taken into account. The protocols still have to produce money, therefore over time, fees must more than offset any incentives given. Otherwise, a token would simply get more and more inflated as a result.</p><p dir="ltr">CLOBs approach incentives in an entirely different way. When a user puts in a market order, they are taking liquidity from the order book and are usually charged a taker fee. However, when a user sets a limit order, they are adding liquidity to the order book and may be eligible for a maker fee if their order is filled. Because there is no risk of irreversible loss, incentives are less important. However, it may be argued that CLOBs, like AMMs, can use a governance token to incentivize limit orders. This could help bootstrap tokens with high spreads and poor liquidity, for example.</p><h3>Order type</h3><p dir="ltr">Perhaps the recent impetus for CLOBs is due to the increase of perps and derivatives. One thing is certain: CLOBs offer more flexibility for diverse order kinds out of the box. Limit orders, for example, are currently included in the design, but other forms such as stop losses, trailing stops, options, leverage, and so on may be added.</p><p dir="ltr">On the other hand, while offering limit orders is not impossible for an AMM, it is a comparable issue. Particularly when it comes to more specific order types and leverage.</p><h3>Pairs type</h3><p dir="ltr">While CLOBs are designed for trading, AMMs are designed for liquidity. This is most noticeable in the ability to use a 3/4pool. The order book for CLOBs is between two tokens, hence having more than two tokens in a pair is impossible. What is the significance of this?</p><p dir="ltr">In terms of capital efficiency, imagine you wanted liquidity between USDC/USDT/DAI. To trade across all three markets using a CLOB, you would need at least two pairings, such as USDC/USDT and USDC/DAI. In the instance of USDT to DAI, you'd have to first trade for USDC and then exchange for DAI, making the transaction less efficient. AMMs, on the other hand, may be designed to pool liquidity from all three stablecoins, resulting in more efficient liquidity aggregation and allocation.</p><h3>MEV&nbsp;</h3><p dir="ltr">MEV attack danger is frequently mentioned as a problem for AMMs. Although frontrunning and sandwiching are legitimate concerns for AMMs, they are not wholly intrinsic issues. AMMs are developing zero-knowledge solutions, for instance, to encrypt transaction data before it is verified by validators and made available to the public. In this case, Osmosis comes to our mind. Secret Network is another illustration, which employs trusted enclaves to carry out encrypted transactions. Similar to how most order books may be said to be off-chain and security concerns, this is not an innate feature of an order book. Naturally, AMMs are constructing MEV solutions in the same manner that CLOBs are constructing an on-chain future. In spite of this, market orders made on a CLOB remain vulnerable to frontrunning, and MEV attacks are not limited to AMMs.</p><h2>The combination of AMMs and CLOBs</h2><h3>Serum</h3><p class="prosemirror-p-center"><img src="https://cdn.builder.news/news/11ed40a2d57cc9fea8e6023f659fee92.jpg" alt="serum solana" title="serum solana" width="600" height="337" class="lykafe1"></p><p>In the Solana ecosystem, Serum is a CLOB. The protocol does not have its own specific front-end. Instead, the protocol concentrates on the infrastructure layer, making it possible for other projects to compose and develop on top of Serum.</p><p dir="ltr">Raydium and Atrix are two of these projects. They operate similarly to traditional AMMs with liquidity pools, with the exception that they connect to Serum to offer liquidity in the shape of limit orders on the book in return for maker fees. Atrix appears to place more emphasis on the market making since they have removed all swap fees from their protocol and derive all of their money by providing liquidity to Serum.</p><h3>Demex</h3><p class="prosemirror-p-center"><img src="https://cdn.builder.news/news/11ed40a2d57ccefda8e6023f659fee92.jpg" alt="demex" title="demex" width="600" height="224" class="lykafe2"></p><p>Demex is similar to the preceding example in many aspects. The fundamental distinction is that, whereas Serum focuses just on the order book, leaving liquidity and market creation to other protocols, Demex develops an all-in-one solution. Demex has its own order book, but it also features liquidity pools, similar to an AMM, that input limit orders into the order book. This isn't to say Demex has a better design; Serum's composable technique offers advantages. The goal is merely to provide light on how other projects incorporate AMMs and CLOBs.</p><p><strong>Conclusion</strong></p><p dir="ltr">Considering how long AMMs have existed, they are swiftly growing and adapting to correct their flaws. But what makes AMMs special in terms of value? What distinguishes AMMs from CLOBs? As this article of <a href="https://www.builder.news/" alt="Builder news" title="Builder news" target="_blank" rel="" class="">Builder.news</a> has already revealed, <strong>CLOBs</strong> appear to be the preferable trading solution. They provide traders with reduced slippage and order-type flexibility. It also makes it logical that institutional actors are increasingly inclined to use instruments from conventional finance as DeFi use rises. But CLOBs have a major issue with democratizing liquidity.</p><p dir="ltr"><strong>AMMs</strong> may choose to optimize for liquidity rather than trading. After all, at <a href="https://www.builder.news/sub-category/defi" alt="DeFi" title="DeFi" target="_blank" rel="" class="">DeFi</a>, liquidity still reigns supreme. AMMs might act as decentralized market makers to interact with CLOBs, distributing liquidity throughout an order book and concentrating on market maker costs. In order to pool liquidity, this would do away with the need for skilled or centralized market makers in favor of automated and permissionless protocols. Even if some of these linkages have already been implemented, AMMs can yet be improved as liquidity centers.</p><div class="pr-block-special"><strong>Disclaimer:</strong><br>This article is intended for and only to be used for reference purposes only. No such information provided constitutes advice or a recommendation that any investment or trading strategy is suitable for any specific name.</div>

There is growing concern about the reigning position of Automated Market Makers (AMMs) and how they will coexist with Central Limit Order Books (CLOBs).

Automated Market Makers vs. Central Limit Order Books: The Clash Of DEXes