Once known as the cornerstone of DeFi, will AMM decline in the future?
Billions of dollars have flowed into decentralized exchange protocols based on the Automated Market Maker (AMM) model, which uses project tokens to incentivize liquidity and channel network effects to create a self-contained set of traders and gainers ecosystem.
The automated market maker model enables DEXs to compete with CEXs with the ability to use cash on their balance sheets to pay user acquisition fees (such as bonuses for signups and referrals). Therefore, AMMs are hailed as the cornerstone of DeFi, derived from various forms, and triggered the popularity of liquidity mining, attracting billions of dollars into smart contracts.
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The decline of AMM
AMM simplifies the market-making mechanism of encrypted currency assets into the simplest financial prototype. The two liquidity pools are combined with the exchange rate and are naturally adjusted according to market demand. Almost like an ancient merchant standing between two piles of grain and beans, exchanging one for the other on request.
This inefficient model means that the biggest beneficiaries are not liquidity providers or traders, but arbitrageurs:
Traders need to live with high gas and inefficient execution. AMMs are isolated from each other, with little interoperability, and traders deploy funds on different protocols and blockchains in search of deep liquidity.
Liquidity providers passively sell tokens with rising exchange rates and buy tokens with falling exchange rates. When digital assets are purchased from sellers and before they are sold to buyers, their value declines, resulting in impermanent losses. Therefore, unlike market makers who are active on exchanges, they may suffer losses from currency price fluctuations in the market.
At the same time, arbitrageurs enter the pool and buy low-priced assets until the asset pool is priced correctly.
Developers have attempted to patch these issues, tweaking parameters and introducing new features such as impermanent loss insurance and third-party interfaces to manage transactions. But there are limits to what can be done. The impermanent loss is built-in and cannot be fully eliminated, only passed on to other protocol participants who manage risk by sharing profits and losses.
In the end, the only way to ensure that liquidity providers on the AMM continue to make profits is to offset losses through high incentives for newly created tokens.
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The rise of middleware
Over time, the AMM model is threatened by another inherent blockchain limitation: the lack of interoperability.
Yield-yielding activity spurred by token incentives exceeds the scalability of the underlying blockchain. This drives up fees and delays transactions, prompting liquidity providers to switch to AMMs running on new sidechains, layer 2s, and next-generation layer 1s.
But each new blockchain is an island. Moving assets across chains, especially between layer-2 networks that are isolated from each other, can mean being forced to go back to the original layer before jumping to the final destination. In the process, liquidity providers' income is consumed by the underlying blockchain gas fee, and they have to go through long queues, not to mention, the headache of tracking funds in different locations.
In this multi-chain future, middleware has a great opportunity to become the first stop of liquidity.
Interoperable middleware can interact trustlessly with different chains, finding the most efficient trading route among multiple sources of liquidity, whether it is from a Uniswap pool or a DEX like Serum that supports centralized order book trading. In this way, we can enjoy the same fun as layer-1 transactions, but without transaction delays, high gas costs, and isolation from each other to prevent cross-chain operations. For end users, the underlying protocol or platform that provides liquidity is only abstracted through a single user interface, similar to the"HTTPS "secondary title
User-centric Token Economic Rules
Without the inherent limitations of AMMs, Layer 2 middleware is better able to accumulate value and create a sustainable crypto-economy that rewards all users.
This means going beyond the token incentives that power layer 1 blockchains, beyond the 2017"Safety"and"Safety"Tokens, and governance tokens beyond DeFi.
The new token economic model not only rewards liquidity providers and verifiers, but also motivates all users on the network to generate real long-term network value. With this, not only traders will flock to middleware to save gas fees and improve transaction efficiency, developers will also take advantage of the efficiency of the second layer to build DeFi applications, and liquidity providers will come to get the most favorable compensation.
Suddenly, the liquidity war between AMMs raging on the underlying chain will be fought on a new battlefield.
The views, thoughts and opinions expressed here are solely those of the author and do not represent the views and opinions of Cointelegraph.
Compilation: Bibabu
Compilation: Bibabu
