Order books vs automated market makers

A book is a list of resting orders on each side. Buyers queue at the prices they are willing to pay, sellers at the prices they will accept, and a trade happens when the two overlap. Nobody computes the price; it is simply the highest bid and the lowest ask at any moment, and the gap between them exists because no participant has chosen to close it.

Two things follow. First, there may be no price at all: a market with a bid of 40¢ and an ask of 70¢ is functioning correctly and is unusable. Second, you have a choice about how to trade — take the price on offer and pay the spread, or post your own and wait. That choice is the main practical freedom an order book gives you.

The cost is visible in two places, both readable before you commit. The spread tells you what the first contract costs relative to the midpoint. The depth at each level tells you what happens to that cost as your size grows.

An automated market maker replaces the queues with a rule. The venue holds a pool of value, a formula turns the state of that pool into a price, and any trade both executes against the pool and changes it — so the act of buying pushes the price up and the act of selling pushes it down. There is always a price available, however obscure the market, which is the design’s whole point.

Because there is no queue on either side, there is no bid and no ask, and therefore no spread to quote. A price from an automated maker is a single number. Manifold works this way, which is one reason a Manifold market on an obscure question has a price at all when an equivalent order book would be empty.

What the single number does not tell you is what you would pay. The quoted price is the price for an infinitesimally small trade. A real trade moves along the formula, and the average price you get is worse than the price you saw — always, and by an amount that grows with your size relative to the pool. That is slippage, and unlike a spread it is not printed anywhere.

On a book, size costs you by walking the levels. If the ask is 62¢ for thirty contracts, 64¢ for fifty and 67¢ beyond, a hundred contracts costs 30 × 0.62 + 50 × 0.64 + 20 × 0.67 = $18.60 + $32.00 + $13.40 = $64.00. The average is 64¢, two points worse than the headline, and every input to that calculation was visible before you sent the order.

On an automated maker the same arithmetic happens continuously rather than in steps, and none of it is visible. You see one number, you trade, and the fill comes back worse. Some interfaces show an estimate before confirmation, which is genuinely useful and is the thing to look for; the formula and the pool size are what determine it.

This has a consequence for anything that compares prices between venues. A quote from an automated maker arrives with a spread of zero, and a spread of zero looks like a costless trade. Any comparison that trusts it will conclude that capturing a gap against that venue is free, which is arithmetic manufacturing an opportunity out of a missing field. Our own comparison logic handles it by assuming a minimum round-trip cost of two points on a quote from an automated maker rather than believing the zero — a deliberate over-estimate, on the principle that an unknown cost assumed absent invents edges while an unknown cost assumed present only suppresses marginal ones.

The tell is whether the interface shows you two prices or one. A bid and an ask, or a depth chart with steps in it, means an order book. A single percentage with a slider and an estimated fill means an automated maker. Some venues run both, with a maker seeding liquidity into a book, in which case you get a spread and slippage together.

It matters for how you read the number and for how you trade it. On a book, a limit order is a real tool and patience is worth something. On an automated maker there is usually nothing to post — you take the formula’s price or you do not trade — so size discipline replaces order-type discipline.

It also matters for what the price is evidence of. A book’s midpoint is where two people stopped disagreeing. An automated maker’s price is where the pool currently sits, which reflects the net of everyone who has traded against it and can drift a long way on a small amount of one-sided flow.