An Order Book versus Automated Market Maker (AMM): The Difference?
Without centralized exchanges, DeFi wouldn't have been this successful.
Problems faced by traders in CEXes fast-tracked the shift to DeFi and other non-custodial options. Still, they complement each other. DeFi and CEXes work towards the same goal—of promoting crypto adoption—with both options available to the undiscerning trader.
At the heart of DeFi is the Automated Market Maker (AMM) model. This diverges with the Order Book most traders in traditional circles are accustomed to.
What is the difference between the two approaches?
To understand how they differ means appreciating DeFi's goal of eliminating the middleman. As the word suggests, centralized exchanges are centralized—, and this is where order books come into play.
An order book model relies on a matching engine that matches sell and buy orders of a given pair based on a given set of rules. Using this style, traders are shielded by a fair price formulation policy and variable spreads. The more liquid a token is, the lower the spread. In general, the order book model means fast processing speeds and higher liquidity.
On the other hand, the AMM model enables trustless swapping of tokens through incentivization and incorporation of a deterministic algorithm for the determination of the price of the base or quote currency.
Herein, liquidity is pooled, aggregating the liquidity of both sides of a trade. Whenever a trader wants to swap tokens, a bot automatically quotes prices.
Liquidity challenges often plague AMMs, and scaling relies on the underlying platform.