How does the vAMM (Virtual Automated Market Maker) set by Bandot reduce the loss of impermanence?

On September 28, Huobi Research Institute gave you a lesson about AMM. If you haven’t read it, I suggest you study it.

The article summarizes all the factors that affect the profit and loss of liquidity market makers in the AMM mechanism, mainly in four aspects:

1. gas cost
2. Market maker fee income
3. Profit and loss caused by price fluctuations
4. Impermanence loss

To put it simply, impermanence loss is the difference between storing tokens in AMM and storing them in a wallet. This happens when the token price in AMM deviates in any direction. The greater the difference, the greater the loss of impermanence.

How to reduce the loss of impermanence

If the relative prices between the tokens in AMM remain the same (assuming that none of them fail), the liquidity provider bears less risk and is more confident in their ability to profit from transaction fees .

Therefore, it turns out that AMM with “mirror assets” (or tokens that maintain a constant price ratio) has a particularly strong resistance to permanent losses and attracts a large amount of liquidity due to its profit-optimized structure.

These include AMMs such as sETH/ETH on Uniswap, and AMMs based on stable coins such as DAI/USDC/USDT/sUSD on Curve.

Since there is almost no difference between ETH and ETH prices, the permanent loss of ETH/ETH AMM is negligible.

However, AMM with mirrored assets is inherently limited to stablecoins or packaging and synthetic tokens. In addition, users cannot maintain their long positions, but must hold additional “reserve” assets while providing liquidity.

How does the vAMM (Virtual Automated Market Maker) set up by Bandot achieve this “reserve” asset?

Since the virtual fund pool can absorb and store a large amount of external funds, it is a “buffer” between the external financial shock and the physical fund pool;

In vAMM, it coexists with the physical fund pool, and the virtual fund pool can be used as a buffer pool of the physical liquidity pool.

When the supply of tokens increases, it does not just flow into the physical fund pool field. The virtual fund pool will diverge part of it, and sometimes even the vast majority. That is, when the money supply increases, the physical fund pool does not increase the amount of money too much, not only there is no inflation, but even continuous deflation may occur. In the virtual fund pool system, these funds will flow out of the virtual fund pool when the physical fund pool needs it, and flow into the virtual fund pool when not needed.

The funds stranded in the virtual fund pool are always flowing out and in, which gives it the function of allocating funds, which is challenging the traditional resource allocation mechanism.

How do we reduce the losses caused by price fluctuations?

Another problem is price discovery. When the price discovery mechanism is missing, profit and loss problems will arise.

Bancor 2.0 attempts to introduce the latest market fair price outside the chain through the oracle machine, and add it to the AMM algorithm to reduce the possibility of market makers being directly arbitrage.

The vAMM adopts a two-way data verification mechanism. The system collects relevant valid transaction data information from the virtual automatic market maker pool and external oracles, and aggregates it into the data algorithm pool for data screening, data statistics and data valid verification to form the final transaction The data is sent back to the fund index device. The value data generated by the fund indexer is directly fed back to the current physical fund pool transaction.

This will also be an important oracle in Polkadot’s internal ecology, which can provide real and reliable economic data sources for different parachains

Specifically, we can first take a look at how it works.

1. When the liquidity provider stores funds in the fund pool, not all the funds will immediately enter the physical fund pool. The system allocates the quota according to the current ratio of the liquidity of the different pools to the tokens. If the pool ratio reaches a certain time, then The remaining part will be allocated to the virtual pool as storage, but it does not affect investors’ income.
2. The amount of the virtual fund pool directly belongs to the smart contract management pool, and the corresponding virtual tokens are locked and generated.
3. The funds in the virtual pool will be linked with the physical fund pool in real time, and the funds between the two will continue to enter and flow out according to the actual situation of the fund pool.
4. The virtual capital pool is equivalent to a comprehensive asset storage management pool, which allocates all assets into high-liquidity assets and low-liquidity assets.
5. The fund allocation module is responsible for combining all assets and configuring trading pairs. All trading pairs will finally realize the ability of simulated robot trading in the virtual trading pool, and finally transmit all the simulation data results to the fund indexer.
6. The fund indexer realizes the multi-directional data collection capability, realizes the chainlink link to collect the value data outside the chain, and realizes the internal transaction data (physical fund pool and virtual fund pool) inside the system, and then conducts statistical analysis of the data to obtain the final reasonable Transaction data.

conclusion

Based on various market-making strategies, collaborative smart contracts can be deployed to generate market orders that maximize returns. Such toolboxes and frameworks have opened up new liquidity and market-making models not only for the cryptocurrency market but also for real-world commodities.