Conceptual Flaws of Decentralized Automated Market Making - Andreas Park
Speaker : Andreas Park (University of Toronto)
Decentralized exchanges (DEXes) are an essential component of the nascent decentralized finance (DeFi) ecosystem. The most common DEXes are so-called automated market makers (AMMs), smart contracts that pool liquidity and process trades as atomic swaps of tokens. AMMs price transactions with a deterministic liquidity invariance rule that only uses the AMM’s token deposits as inputs and that has no precedent in traditional finance. Yet in the context of transparent and open blockchain operations, any liquidity invariance pricing function allows so-called sandwich attacks (akin to front-running) that increase the cost of trading and threaten the long-term viability of the DeFi eco-system. Linear price rules that commonly emerge in economic models have similar problems, except for uniform pricing for which sandwich attack profits are limited and smaller, but which invites excessive order splitting.