An Important Driving Force in the Web3 Financial Sector: An Analysis of the AMM Mechanism

In the current landscape of the Web3 industry, decentralized finance ( DeFi ) related products dominate the market. Among them, automated market makers ( AMM ) play a key role in vigorously promoting innovation and development in the Web3 financial sector. This article will delve into several important AMM implementations within the Solana ecosystem, aiming to provide valuable references for liquidity providers ( LP ) in their investment strategy choices.

Constant Product Market Maker ( CPMM )

CPMM is one of the most basic implementations of AMM, used in various DeFi products. Taking the constant product AMM launched by a certain trading platform as an example, its core principle is to maintain a constant product of the supply of two tokens in the pool, that is, X * Y = k.

When an LP adds liquidity to the pool, the system automatically creates a linked account for the user's wallet and issues LP Tokens to prove their share of the pool. When extracting liquidity, the corresponding LP Tokens will be burned.

The on-chain program of CPMM is developed using Anchor. When performing token swaps, user actions will trigger swap-related commands. Taking the TRUMP-USDC trading pair as an example, when a user exchanges USDC for TRUMP, the operation will be completed through the pool of that trading pair.

In the specific swap calculation, CPMM uses the constant product formula:

(X + ΔX)(Y - ΔY) = XY

The calculation formula for the output token quantity ΔY can be obtained through mathematical transformation:

ΔY = (ΔX * Y) / (X + ΔX)

It is important to note that this calculation does not include fees, as the fees have already been deducted in the preceding logic.

Concentrated Liquidity Market Maker ( CLMM )

CLMM draws on the design concept of a certain DEX V3, allowing for multiple fee tiers to be set for each token pair and creating pools corresponding to those tiers. CLMM inherits core concepts such as ticks, multiple fee tiers, and concentrated liquidity.

Similar to CPMM, due to the characteristics of the Solana chain, CLMM does not need to deploy a contract for each pool individually, which is different from the implementation on Ethereum.

CLMM allows LPs to select a price range when injecting funds, and the funds will only be distributed within the selected range. This mechanism enables LPs to provide what is known as "unilateral liquidity," similar to limit orders in traditional finance.

Generally speaking, for pools with smaller price fluctuations, LPs tend to choose a narrower price range; while for pools with significant fluctuations, they tend to choose a wider range. The purpose of this is to minimize the risk of the current price deviating from the selected range and to reduce impermanent loss risk.

It is important to note that while concentrated liquidity can improve capital utilization, it also places higher demands on LP's financial management capabilities. LPs need to manage their liquidity more actively to cope with the potential risks brought about by market fluctuations.

Dynamic Liquidity AMM ( DLMM )

DLMM is another AMM product based on V3 design, which has similarities with CLMM, but there are differences in specific implementation and functional features.

DLMM introduces the concept of "Bin", dividing the pool into Bin units starting from the base price, with each Bin step representing a small interval. If a trade occurs within the same Bin, traders will enjoy zero slippage advantages, which helps increase trading volume and success rates, theoretically allowing LPs to earn more transaction fee income.

In DLMM, the tokens in the pool are also distributed on both sides of the current price, and a single token only needs to provide unilateral liquidity. The currently activated Bin has two types of tokens, while other Bins only have a single token.

DLMM provides LPs with three liquidity strategies:

1. Spot Strategy: Suitable for most liquidity pools, it is the most basic liquidity strategy.

2. Curve Strategy: More suitable for pools with small price fluctuations, such as stablecoin pairs. By concentrating funds within a small range, it maximizes trading fee revenue.

3. Bid Ask Strategy: Suitable for pools with large price fluctuations. This strategy requires LPs to frequently adjust positions to respond to drastic price changes, which demands a high level of market judgment.

Conclusion

As a core component of the Web3 financial ecosystem, the AMM mechanism is driving the popularization and development of decentralized finance through its unique design and innovative applications. With continuous technological advancement and an increasingly完善 ecosystem, AMM is expected to play a greater role in the future, further reshaping the traditional financial landscape. For participants, a deep understanding of the characteristics and advantages of different AMM mechanisms will help in formulating more informed investment strategies and seizing opportunities in the wave of Web3 finance.