What are liquidity pairs, liquidity pools, and AMM?
Let’s start with a traditional finance topic that you may already be familiar with: order books. An order book records buy orders and sell orders for an asset, like stocks, and sorts them by their prices. In order for a transaction to be executed, there needs to be a match in buy and sell orders.
In DeFi, many exchanges instead use an Automated Market Maker, or AMM. An AMM is a system in which you can always swap two assets without waiting for a match like you would in a traditional order book. The AMM instead uses an algorithm to quote you a price in the moment that you are ready to execute a transaction.
How can an AMM figure out how to quote your price? It uses a liquidity pool which contains a liquidity pair.
In order to gain value, a token is paired with another token, usually the native coin of that blockchain, to create the liquidity pair. For example, Bridges has its own token—Bridge$ (BRG.X)—which is paired with BNB. The liquidity pair is the set of two tokens that make up a liquidity pool.
A liquidity pool is filled with each of the tokens in the liquidity pair. Let’s think about buying and selling Bridge$ to better understand this concept. When you buy Bridge$, you put BNB into the liquidity pool and take Bridge$ out. When you sell, you return Bridge$ to the liquidity pool and get BNB back. The ratio of those two tokens depends on the price quoted to you by the AMM.
For a given liquidity pair, you always need to have one of the tokens in order to get the other. This is why in order to buy Bridge$ and most other tokens on BNB Chain, you need to have BNB. There are some platforms, like Bridges Exchange, that allow for multi-hop swaps. In these types of swaps, you enter two tokens that have no liquidity pair together, and the exchange does multiple swaps in the background. For example, if you want to use BUSD to swap for Bridge$, the exchange will first swap BUSD for BNB, then use that BNB to swap for Bridge$.