Definition
- AMMs: Decentralized exchanges using algorithmic models to provide liquidity for crypto assets.
- Functioning: Users trade directly through AMMs, bypassing traditional order books.
Liquidity Pools and Providers
- Liquidity Pools: Crowdsourced asset collections used by AMMs for trading.
- Liquidity Providers (LPs): Users depositing assets into pools, earning fees and rewards.
AMM Models
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Constant Product Market Maker (CPMM)
- Formula: x * y = k
- Function: Maintains liquidity via a constant product, affecting token prices.
- Example: Popularized by Bancor and Uniswap.
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Constant Sum Market Maker (CSMM)
- Formula: x + y = k
- Function: Creates a linear price curve but susceptible to liquidity drainage.
- Less Used: Due to risks of one-sided liquidity depletion.
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Constant Mean Market Maker (CMMM)
- Formula: (x * y * z)^(⅓) = k
- Function: Enables more than two tokens in a pool with variable weightings.
- Versatility: Supports varied exposure to assets within a pool.
Issues with First-Generation AMM Models
- Impermanent Loss: Loss faced by LPs due to token price divergence.
- Low Capital Efficiency: Large liquidity needed for effective trading due to AMM design.
Improvements and Innovations
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Hybrid CFMMs
- Example: Curve Finance combining CPMM and CSMM for better liquidity and reduced price impact.
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Dynamic Automated Market Makers (DAMM)
- Function: Adapts liquidity based on changing market conditions, using dynamic variables.
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Proactive Market Makers (PMM)
- Function: Mimics traditional market-making behaviors to increase liquidity near market price.
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Virtual Automated Market Makers (vAMM)
- Function: Offers exposure to synthetic assets with reduced price impact and impermanent loss.
Conclusion
- AMMs revolutionize trading through algorithmic liquidity provision.
- Models vary in formulas and functionalities, each with strengths and limitations.
- Innovations seek to overcome impermanent loss and enhance liquidity efficiency in AMMs.