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Next Gen AMM
VeradiVerdict - Issue #192
Liquidity provision in automated market makers (AMMs) remains a significant issue, despite numerous architectures of decentralized exchanges and liquidity mining protocols that have surfaced over the past few years.
Automated market makers need liquidity providers to commit their assets to each side of a pool for traders to be able to swap one of their assets for another. These liquidity providers are incentivized with a fee relative to the volume of such trades, which results in the optimal strategy of allocating their capital to the most needed pools.
When a user performs a trade in the pool, the price of one asset relative to another in the pool is shifted relative to the trade amount. This results in the trader incurring slippage—the premium they pay on top of the initial price in the pool.
The price of each asset could also move outside the pool, in which case corrective action must be taken to move the price within the pool to match that of the broader market. Luckily, arbitrageurs can perform trades that move the price between the pool and other exchanges to bring the prices closer to each other with little to no risk. However, this riskless profit directly comes out of the liquidity providers’ pockets, which we call the impermanent loss incurred by liquidity providers.
Therefore, efficient AMMs and possibly other auxiliary liquidity mining protocols are needed to minimize these two costs—slippage and impermanent loss—in order for capital to be allocated more efficiently in the market. Maverick protocol introduces a novel AMM architecture that allows both costs to be minimized in ways that could not have been done before.
CPMMs and Concentrated Liquidity
The first major architecture for DEXs was the constant product market maker (CPMM) used by one of the largest decentralized exchanges—Uniswap—in both V1 and V2. Ignoring any additions/removals of liquidity by liquidity providers, we can represent the amounts of each asset using a curve as shown below. Each point along this curve represents a different amount of each asset possible under the “constant product” invariant. So, each trade made corresponds to moving along the curve. The more bent some portion of the curve is, the higher the slippage incurred by traders. However, the higher liquidity there is, the less bent the curve is as a whole, and therefore slippage is lower.
An example of a curve representing different quantities of each asset represented by each axis in Uniswap V2.
Notice that CPMMs allocate capital along the entire curve equally, which means that there is a lot of liquidity that is unused close to current prices where trading happens the most. However, the main benefit of this is that each share of the liquidity pool is the same and can be represented as an ERC20, which allows for composability with other DeFi protocols.
Uniswap V3 introduced the concept of concentrated liquidity which allows liquidity providers to commit liquidity within a chosen certain range on the curve, each position now represented as an NFT. This allows for a more efficient distribution of liquidity, as regions where trading happens the most can be allocated more liquidity. Those regions on the curve are flattened and thus slippage is lowered, which is appealing to traders but the risk of impermanent loss is increased for liquidity providers.
Nonetheless, both models of DEXs have their own problems:
In the concentrated liquidity model, liquidity providers need to be highly sophisticated to be profitable due to the higher risk of impermanent loss in volatile market conditions. This means retail investors are not able to profitability participate in liquidity provision. Even then, the majority of liquidity providers on Uniswap V3 lose money. Furthermore, CPMMs are becoming less and less profitable as concentrated liquidity is cheaper for traders, lowering fees for CPMM liquidity providers while incurring the same impermanent loss risk.
Slippage and impermanent loss
Even in Uniswap V3, slippage can be a problem, mostly due to liquidity being misallocated outside of optimal regions. Arbitrageurs will always gain from the impermanent loss incurred by liquidity providers in volatile market conditions. When liquidity is misallocated, the impermanent loss is even higher than that of CPMMs since arbitrageurs are able to swap more assets before moving the pool price to match the broader market price. Furthermore, concentrated liquidity is vulnerable to front-running attacks.
Though liquidity providers in Uniswap V2 are able to represent their shares as ERC20s, this is no longer possible for liquidity providers in Uniswap V3, as they are given the flexibility of choosing their own range to provide liquidity. The NFTs that represent LP positions in Uniswap V3 are very difficult to price and risk-assess in secondary markets and are therefore difficult to compose with other DeFi protocols, especially for collateral.
Enter Maverick Protocol
So, how does Maverick work, and how does it solve these problems?
Maverick incorporates an automated liquidity placement mechanism in its AMM to combat slippage and impermanent loss. As the price in a trading pool moves in response to trading activity, the AMM natively and intelligently shifts the range of provided liquidity to match the new prices, limiting slippage and impermanent loss.
An illustration of how Maverick’s AMM shifts liquidity provision along different ranges of prices when market prices move.
Let’s see how Maverick helps address some of the problems we identified above. First of all, since Maverick is able to provide an easy way for retail users to become profitable liquidity providers, it democratizes access to liquidity provision opportunities. Due to the optimal allocation of liquidity, traders also incur less slippage and liquidity providers incur less impermanent loss than in Uniswap V3. Finally, LP positions are fungible since they all represent the same strategy and are easier to value, so such positions can be represented as ERC20s and are therefore more composable with other DeFi protocols.
What is the competitive landscape like?
Uniswap V3 is the market-leader among DEXs, accounting for ~30% of trading volume. Although V3 was designed to address the efficiency issues with V2’s vanilla CPMM, these improvements came at the cost of increased complexity. This has placed more responsibility on LPs to manage their capital effectively, both to enhance their own profits and to ensure low slippage for traders. By automating liquidity management, Maverick’s AMM brings back the simplicity of the V2 LP experience while retaining the enhanced efficiency of V3: the best of both worlds.
Uniswap V3 liquidity managers
These are protocols that manage liquidity provision in Uniswap V3 on behalf of liquidity providers through pooling capital into unified strategies (e.g. Charm.fi). The advantage of this over normal Uniswap V3 liquidity provision is more optimal liquidity allocation and decreased gas costs with scale. However, these protocols often charge management and carry fees which increases the cost of running these strategies for liquidity providers. Maverick obsoletes this cost by incorporating optimal liquidity allocation into the AMM model itself.
Maverick’s novel AMM design introduces unprecedented levels of capital efficiency into the market by lowering impermanent loss risk and slippage. This is both appealing to traders and liquidity providers, which will allow Maverick to capture a significant share of the market.
Maverick is preparing to launch a swap product based on this compelling AMM technology, and it will be exciting to see the capital efficiency improvements that it should present in swap markets. A key feature of this product will be the ability of users to open new trading pools easily and efficiently, since the intelligent management of liquidity offered by Maverick’s AMM should guarantee high efficiency, even for long-tail assets. In the future, this same AMM technology could be used to support derivatives products like perpetual futures, extending Maverick’s reach from spot markets to a larger DeFi ecosystem.
The bottom line is that Maverick has developed technology that is likely to capture a large portion of the decentralized finance market and is a compelling investment.
- Paul Veradittakit
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Hi, I’m Paul Veradittakit, a Partner at Pantera Capital, one of the oldest and largest institutional investors focused on investing in blockchain companies and cryptocurrencies. I’ve been in the industry since 2014, and the firm invests in equity, early stage token projects, and liquid cryptocurrencies on exchanges. I focus on early-stage investments and share my thoughts on what’s going on in the industry in this weekly newsletter.