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Automated Market Makers

Author

Listed:
  • Mohsen Pourpouneh

    (Department of Food and Resource Economics, University of Copenhagen)

  • Kurt Nielsen

    (Department of Food and Resource Economics, University of Copenhagen)

  • Omri Ross

    (eToroX Labs, University of Copenhagen)

Abstract

A new type of Automated Market Makers (AMMs) powered by Blockchain technology keep liquidity on-chain and offer transparent price mechanisms. This innovation is a significant step in the direction of building a more transparent and efficient financial market. This paper explores analytically market mechanisms and shows the conditions when those mechanisms are equivalent. Furthermore, we show that AMM mechanisms inherently create loses for market makers from inefficient prices (dictated by the AMM solutions), however, these mechanisms work well for assets with low volatility. We further analytically explore the losses and quantify them. The paper ends by discussing the design of efficient decentralized exchange compared to traditional Central Limited Order Books (CLOBs) and highlights the former’s potential regarding decentralized finance.

Suggested Citation

  • Mohsen Pourpouneh & Kurt Nielsen & Omri Ross, 2020. "Automated Market Makers," IFRO Working Paper 2020/08, University of Copenhagen, Department of Food and Resource Economics.
    • Handle: RePEc:foi:wpaper:2020_08
    as

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    File URL: http://okonomi.foi.dk/workingpapers/WPpdf/WP2020/IFRO_WP_2020_08.pdf
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    References listed on IDEAS

    as
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    3. Alok Gupta, 2018. "Editorial—Traits of Successful Research Contributions for Publication in ISR : Some Thoughts for Authors and Reviewers," Information Systems Research, INFORMS, vol. 29(4), pages 779-786, December.
    4. Gandal, Neil & Hamrick, JT & Moore, Tyler & Oberman, Tali, 2018. "Price manipulation in the Bitcoin ecosystem," Journal of Monetary Economics, Elsevier, vol. 95(C), pages 86-96.
    5. Roman Beck & Michel Avital & Matti Rossi & Jason Bennett Thatcher, 2017. "Blockchain Technology in Business and Information Systems Research," Business & Information Systems Engineering: The International Journal of WIRTSCHAFTSINFORMATIK, Springer;Gesellschaft für Informatik e.V. (GI), vol. 59(6), pages 381-384, December.
    6. Benjamin Egelund-Müller & Martin Elsman & Fritz Henglein & Omri Ross, 2017. "Automated Execution of Financial Contracts on Blockchains," Business & Information Systems Engineering: The International Journal of WIRTSCHAFTSINFORMATIK, Springer;Gesellschaft für Informatik e.V. (GI), vol. 59(6), pages 457-467, December.
    7. Eric Budish & Peter Cramton & John Shim, 2014. "Implementation Details for Frequent Batch Auctions: Slowing Down Markets to the Blink of an Eye," American Economic Review, American Economic Association, vol. 104(5), pages 418-424, May.
    Full references (including those not matched with items on IDEAS)

    Citations

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    Cited by:

    1. Vijay Mohan, 2022. "Automated market makers and decentralized exchanges: a DeFi primer," Financial Innovation, Springer;Southwestern University of Finance and Economics, vol. 8(1), pages 1-48, December.
    2. Vincent Gramlich & Tobias Guggenberger & Marc Principato & Benjamin Schellinger & Nils Urbach, 2023. "A multivocal literature review of decentralized finance: Current knowledge and future research avenues," Electronic Markets, Springer;IIM University of St. Gallen, vol. 33(1), pages 1-37, December.
    3. Tobias Bitterli & Fabian Schar, 2023. "Decentralized Exchanges: The Profitability Frontier of Constant Product Market Makers," Papers 2302.05219, arXiv.org, revised Mar 2023.
    4. Tim Weingärtner & Fabian Fasser & Pedro Reis Sá da Costa & Walter Farkas, 2023. "Deciphering DeFi: A Comprehensive Analysis and Visualization of Risks in Decentralized Finance," JRFM, MDPI, vol. 16(10), pages 1-25, October.
    5. Tristan Lim, 2022. "Predictive Crypto-Asset Automated Market Making Architecture for Decentralized Finance using Deep Reinforcement Learning," Papers 2211.01346, arXiv.org, revised Jan 2023.

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    More about this item

    Keywords

    blockchain; decentralized exchanges; automated liquidity providers; auction; mechanism design;
    All these keywords.

    JEL classification:

    • D53 - Microeconomics - - General Equilibrium and Disequilibrium - - - Financial Markets
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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