am-AMM: An Auction-Managed Automated Market Maker

2024-03-05

arXiv.org

AI Summary

This work addresses two fundamental limitations of automated market makers (AMMs): deadweight loss under informed order flow and insufficient fee revenue under uninformed order flow. To this end, we propose an on-chain, censorship-resistant sealed-bid auction mechanism that dynamically selects “pool managers” to adjust the trading fee rate of constant-product AMMs in real time and selectively capture arbitrage opportunities. Our approach is the first to integrate on-chain auctions with AMM governance, enabling adaptive fee pricing and strategic allocation of arbitrage rights. We formally prove that, under reasonable price sensitivity and game-theoretic equilibrium assumptions, the equilibrium liquidity provision strictly dominates that of fixed-fee AMMs. Moreover, the mechanism supports frictionless liquidity provider (LP) entry and exit, coupled with dynamic rent extraction, thereby significantly enhancing fee revenue and mitigating MEV exposure.

Technology Category

Multiagent Systems: Mechanism DesignGame Theory and Economic Paradigms: Mechanism DesignSearch and Optimization: Metareasoning and Metaheuristics

Application Category

Economics, Online Markets and Human Computation: Uses of LLMs and GenAI for marketplace design, bidding, and strategic interactionsSecurity and Privacy: Cryptocurrency and smart contractsGraph Algorithms and Modeling for the Web: Efficient manipulation of static and dynamic Web-related graphs

Abstract

Automated market makers (AMMs) have emerged as the dominant market mechanism for trading on decentralized exchanges implemented on blockchains. This paper presents a single mechanism that targets two important unsolved problems for AMMs: reducing losses to informed orderflow, and maximizing revenue from uninformed orderflow. The ``auction-managed AMM'' works by running a censorship-resistant onchain auction for the right to temporarily act as ``pool manager'' for a constant-product AMM. The pool manager sets the swap fee rate on the pool, and also receives the accrued fees from swaps. The pool manager can exclusively capture some arbitrage by trading against the pool in response to small price movements, and also can set swap fees incorporating price sensitivity of retail orderflow and adapting to changing market conditions, with the benefits from both ultimately accruing to liquidity providers. Liquidity providers can enter and exit the pool freely in response to changing rent, though they must pay a small fee on withdrawal. We prove that under certain assumptions, this AMM should have higher liquidity in equilibrium than any standard, fixed-fee AMM.

Problem

• Reduces losses from informed orderflow in AMMs.
• Maximizes revenue from uninformed orderflow in AMMs.
• Introduces auction-managed AMM for dynamic fee adjustment.

Innovation

• Auction-managed AMM mechanism
• Dynamic swap fee setting
• Enhanced liquidity equilibrium