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What is an Automated Market Maker (AMM)?



AMM, also known as automated market maker, is one of the most critical technologies for decentralized exchanges (DEX) and has proven to be one of the most influential DeFi innovations. They can create and operate for a range of different tokens Publicly available on-chain liquidity. AMM has fundamentally changed the way users trade cryptocurrencies. Unlike the traditional order book trading model, both parties to the AMM transaction are interacting with the liquid asset pool on the chain. Liquidity pools allow users to seamlessly switch between tokens on-chain in a fully decentralized and non-custodial manner. Liquidity providers, on the other hand, earn passive income through transaction fees, which are based on the percentage of their contribution to the asset pool. 1. There are several types of AMMs: Constant Sum Market Maker (CSMM), Constant Mean Market Maker (CMMM), and Advanced Hybrid Constant Function Market Maker CFMM. 2. Some key challenges that AMMs must overcome, including impermanent loss (IL), forced multi-currency exposure, and low capital efficiency. 3. The innovations of Bancor, Uniswap, Curve and other projects make AMM attractive to larger liquidity providers by improving capital efficiency, reducing volatility risk and providing more capital allocation options. 4. Using Chainlink oracles, Bancor aims to solve the impermanent loss (IL) problem of volatile tokens for the first time in the upcoming V2 version. By providing a more comprehensive analysis, we hope to better educate DeFi users on the challenges and innovations of AMMs, so that decentralized liquidity can realize its full potential as a fundamental part of DeFi, and the wider financial world. ChainUP Jiangnan on the Dialogue Chain: 99% new options for exchange technology services - what exactly is the WaaS alliance? : With the launch of Filecoin's main network, the cloud platform on the chain is the first to support the FIL/USDT currency pair, and more than 300 exchanges will be launched simultaneously. One week after its launch, the trading volume of Filecoin currency pairs and its futures on major second-tier exchanges is astonishing. What makes Chainshangyun so keenly grasp market trends? Subsequently, LINK became popular, and the LINK3L futures were launched on the chain cloud at the same time, which once again drove the market and set off a wave of climax. What is the powerful system behind this that can support such a huge amount, and can quickly keep up with the services developed by popular main chains and currencies? Focusing on high-quality projects and grabbing high-quality assets, what makes ChainUP the most trusted and favored transaction system service provider in the blockchain industry? At 20:00 on the evening of July 23, Jiang Nan, a partner of the marketing department of ChainUP, will be a guest of Golden Micro Interview, and show you how ChainUP rides the wind and waves in the technical service track. [2020/7/23] The so-called market makers (MM), they are entities responsible for providing liquidity for the exchange and performing price operations at the same time. This is achieved by MM buying and selling assets from their own accounts, and their purpose is to make a profit, because their trading activities create liquidity for other traders, which reduces the slippage of large transactions. Automated market makers (AMMs), on the other hand, use algorithmic “bots” to simulate these price actions in electronic markets such as DeFi. Although there are different decentralized exchange designs, the AMM-based DEX has always achieved the greatest liquidity and the highest average daily trading volume. Currently, constant function market makers (CFMMs) are the most popular class of AMMs, and they are applied to realize the decentralized exchange of digital assets. These AMM exchanges are based on a constant function, that is, the comprehensive asset reserve of the trading pair must remain unchanged. In a non-custodial AMM, user deposits of trading pairs are centralized in a smart contract, which any trader can use to obtain token swap liquidity. Therefore, users conduct transactions based on smart contracts (collective assets), rather than directly with counterparties (such as order transactions). Since 2017, there have been three preliminary designs of constant function market makers in the market: Live | Six Six - Binance > Why I Choose Binance: "The Currency Circle "Hou Lang" Fairy Live Week" hosted by Jinse Finance Live "The third issue starts on time at 20:00 tonight. In this issue, Liuliu, the new media marketing manager of Binance, a fairy of "Houlang", will chat about "Why I choose Binance" in the live broadcast room. Interested friends scan the QR code to listen! [2020/6/3] The first type to emerge is the Constant Product Market Maker (CPMM), popularized by Bancor and Uniswap. CPMM is based on the function x*y=k, which determines the price range of two tokens based on the available quantity (liquidity) of each token. When the supply of token X increases, the supply of token Y must decrease, and vice versa, to maintain a constant product K. When plotting this function, the result is a hyperbola where liquidity is always available but prices get higher and higher, approaching infinity at both ends. The second type is a constant and market maker (CSMM), which is ideal for zero-slip trading, but it does not provide unlimited liquidity. Constant Sum Market Maker (CSMM) follows the formula x+y=k and when plotting it, a straight line is created. Unfortunately, this design allows arbitrageurs to deplete one of the reserve assets if the off-chain reference price between tokens is not 1:1. This situation would destroy one side of the liquidity pool, forcing liquidity providers to suffer losses, and making traders no longer liquid. Therefore, Constant Sum Market Maker (CSMM) is not a common AMM model. The third type is a Constant Mean Market Maker (CMMM), which allows the creation of AMMs that can own more than two tokens and are weighted outside of the standard 50/50 distribution. In this model, the weighted geometric mean of each reserve asset remains constant. For a liquidity pool with three assets, its formula is as follows: (x*y*z)^(⅓)=k. With the development of AMM technology, we have seen the emergence of advanced mixed constant function market maker CFMM, which combines a variety of functions and parameters to achieve specific behaviors, such as adjusting the risk exposure of liquidity providers or reducing trades The price slippage of the buyer. For example, the Curve AMM uses a combination of CPMM and CSMM to create denser liquidity, which reduces slippage within a given trading range. What it presents instead is a hyperbola (blue line) that returns a linear rate for most trades and an exponential price for larger trades. Internal employee of ofo: I don’t understand what the company’s purpose of doing blockchain is: According to "Changjiang Business Daily", an internal employee of ofo said that the blockchain project is still a secret in the company and has not been made public. "Actually, I didn't understand what exactly to do, how to do it, and what purpose to achieve when ofo works on the blockchain." Ofo has previously confirmed its involvement in the blockchain. On May 17, ofo announced the establishment of a blockchain research institute, which will apply blockchain technology globally to empower big data and the Internet of Things, connect enterprises, governments, users and other parties, and solve shared bicycle delivery, scheduling and parking. , maintenance and other operational pain points, and help solve the urban governance problems of shared bicycles. [2018/6/4] Although DeFi's first-generation AMM asset pools have experienced extensive growth in the past two years, there are still some obstacles preventing them from being widely adopted, including impermanent losses (IL), low capital efficiency, and multiple Token risk. 1. Impermanent loss (IL) Users who provide liquidity to the AMM pool, the main and most common unknown risk they face is impermanent loss (IL), that is, users deposit tokens in AMM and simply deposit tokens In the wallet, there will be a difference in value. This loss occurs when the market price of the token within the AMM deviates in any direction. Since the AMM does not automatically adjust the exchange rate, arbitrageurs need to buy underpriced assets or sell overpriced assets until the price offered by the AMM matches the overall market price in the external market. Arbitrageurs siphoned profits out of the pockets of liquidity providers, causing losses. In the example above, the impermanent losses experienced in the AMM were caused by changes in the market price of ETH due to trading activity on other exchanges. The internal reaction of AMM to this external price change is to readjust the exchange rate in the asset pool to match the exchange rate in the external market. During the rebalancing process of exchanging ETH for BNT, the total reserve of the AMM decreased slightly. The reason why it is called "impermanent loss" is that as long as the relative price of the token in the AMM returns to its original value, this loss will disappear, and the liquidity provider will keep the fee it earns as profit . However, such cases are rare, meaning that most liquidity providers (LPs) suffer "impermanent losses" that exceed the transaction fees they incur. The graph below shows the "impermanent loss" experienced when providing liquidity to an ETH-DAI AMM pool, before accounting for transaction fees. Li Xiaolai: Artificial separation of the blockchain and the Internet is a conflict of interests, there is no "classical Internet": Li Xiaolai said in an interview with the media: "There is no such thing as a 'classical Internet', the Internet is the Internet, and the blockchain is also a part of the Internet .How can you point to the part outside of your stomach and say that this is a 'classical body', and then ask, 'there is an irreconcilable contradiction between this stomach and the classical body'? Artificially split the blockchain and the Internet, The original intention is not the mutual exclusion of theoretical systems, but the competition for interests.” As for the main contradiction of China’s Internet, Li Xiaolai said that he did not know, but only knew that the rapid development of the Internet has caused a greater gap between the rich and the poor, which has triggered certain social conflicts , this is an unavoidable fact. [2018/3/6] 2. Multi-token exposure AMMs usually require liquidity providers (LP) to deposit two different tokens to provide equal liquidity on both sides of the transaction. Therefore, liquidity providers (LPs) cannot maintain their long-term exposure to a single token, but must divide their exposure by holding additional ERC20 reserve assets. Teams with a large amount of one token, or individual holders wishing to provide liquidity, are forced to purchase another asset in order to provide liquidity, thereby reducing their holdings in the asset pool’s base token and increasing their exposure to Exposure to another asset. 3. The problem of low capital efficiency. AMMs have been criticized for requiring a large amount of liquidity to achieve the same level as order book-based exchanges. This is because a significant portion of AMM liquidity is only available when the pricing curve starts to move exponentially. Therefore, most of the liquidity will never be used by rational traders due to experiencing extreme slippage. AMM liquidity providers have no control over the price points offered to traders, which has led some to refer to AMMs as "lazy liquidity", i.e. underutilized and undersupplied. At the same time, market makers based on order book exchanges can precisely control the price point at which they want to buy and sell tokens. This results in very high capital efficiency, but at the same time requires active-ethexc participation and oversight of liquidity provision.  Zhu Xiaohu: The Internet bubble in 2000 still had at least eyeballs. What else does today’s blockchain have besides currency speculation? : On March 1, Zhu Xiaohu shared a block chain application map in his circle of friends, and wrote: "So many so-called block chain applications, except for users who speculate in coins, all these applications together have How many daily active-ethexc users? The Internet bubble in 2000 had at least eyeballs, and today’s blockchain has nothing but speculation.” [2018/3/1] Aiming at many limitations of the first generation AMM, some innovative design models are trying to solve these problems. 1. High capital efficiency and low slippage AMM As mentioned in the previous section, hybrid CFMM makes the exchange rate curve basically linear and parabolic only when the liquidity pool is pushed to the limit, which can achieve extremely low slippage trading. Liquidity providers earn more fees (despite lower fees per trade) because capital is used more efficiently, while arbitrageurs still profit from rebalancing pools. Curve offers low-slippage transactions between tokens with a relatively stable 1:1 exchange rate, which means that its solution is primarily designed for stablecoins, although they recently introduced support for wrapped bitcoin tokens. Supported (eg renBTC and wBTC). Bancor V2 extends this low-slippage model to volatile assets through a similar mechanism, dynamically updates the reserve weight, and maintains the reserve value at a 1:1 ratio. Within the common price region, liquidity can be amplified while retaining an important incentive for arbitrageurs to rebalance pools. 2. Reduce impermanent loss Bancor's goal is to take the lead in solving the impermanent loss of volatile tokens in the upcoming V2 version. Bancor V2 reduces the risk of impermanent losses by using an anchored liquidity reserve, which keeps the relative value of its AMM reserves unchanged. Until recently, this was only done with mirrored asset pairs that maintained a constant 1:1 price ratio. Bancor V2, on the other hand, uses Chainlink oracles to extend this concept to assets with variable exchange rates. With reduced risk for liquidity providers, such a solution would be a major breakthrough in utilizing volatile digital assets in asset management systems. By using Chainlink oracles, the Bancor V2 asset pool is able to maintain an accurate exchange rate even if the price of tokens differs due to changes in external market prices. Rather than arbitrageurs fixing the exchange rate, the oracle provides pricing updates to adjust the weights of the AMM so that the internal exchange rate matches the external market price. The benefit of this is that arbitrageurs no longer take value away from liquidity providers in the form of impermanent losses. Market price changes in Bancor V2, and how it uses Chainlink oracles to eliminate impermanent losses. Instead, arbitrageurs only need to balance the distribution of tokens in the AMM pool in response to token transactions. Bancor V2 always encourages a return to balance, as liquidity providers with low-weight reserves will receive higher ROI until the reserve pool returns to 50/50 weighting. Overall, both users and token teams can have more confidence in their deposit liquidity, which can earn profits from transaction fees and not lose value due to normal market fluctuations. 3. Multi-token exposure Uniswap V2 allows any ERC20 token to be combined with any other ERC20 token into an asset pool, thus eliminating the requirement for ETH from liquidity providers. This gives liquidity providers the flexibility to maintain a more diverse mix of ERC20 token positions and create more potential asset pool combinations for trading to draw liquidity from. Bancor V2 enables liquidity providers to maintain exposure to a single token, removing bilateral liquidity deposit requirements.


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What is an Automated Market Maker (AMM)?

AMM, also known as automated market maker, is one of the most critical technologies for decentralized exchanges (DEX) and has proven to be one of the most influential DeFi innovations. They can create and operate for.

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