A recent report from Consensys says the increase in decentralized exchange volumes (DEX) in the third quarter of 2020 is due to the adoption of the Automated Market Maker (SMP). According to the report, DEXs using AMM, a software that creates algorithmic token trading pairs, now represent 93% of the market.
The good side of AMMs
As a result of the use of the SMP, Uniswap’s volume traded was already $ 15.4 billion in September, a figure nearly $ 2 billion higher than Coinbase’s. Before the increase in the use of SMPs, order books were used instead.
The Consensys Defi report claims that the increase in the use of SMPs is largely due to the fact that they “are seen as a valuable way to reduce the likelihood of human error or manipulation and also to leave a clear audit trail for supervisors”.
According to an excerpt from the report, the “success of the market maker software in Q3 proved that SMPs were ready for the mainstream – so much so that the total value of SMPs on Ethereum was more than $ 4 billion.”
The main difference between SMPs and order books is that liquidity providers do not compete with each other for order flow. All liquidity providers only use liquidity at the prices set by the one algorithm that applies to everyone. The entire order flow is distributed proportionally among all liquidity providers.
The counter story
However, many within the Defi community argue against SMP despite DEX’s embrace. Dmytro Volkov, the CTO at CEX.IO, gives a key point about this:
“(An) AMM creates an inefficient market! Arbitrageurs take a profit from the inefficiencies of liquidity providers, causing liquidity providers to suffer a loss (or loss of profit) to make that happen. This makes such markets very attractive to arbitrageurs, as they basically yield no risk. “
Volkov also notes that “inefficient liquidity providers compete with arbitrageurs, who are professional or highly experienced traders with high-quality, fast-paced arbitrage algorithms.” According to him, the outcome of such a scenario is quite predictable, the professional traders will prevail.
So while the Defi report attributes the increased DEX volume to the use of SMPs, Volkov thinks that liquidity providers currently using this market-making technology are only using it for “simplicity,” despite the possibility that they will incur losses.
Reiterating the same inefficiency point is Sam Bankman Fried (SBF), the CEO of FTX, whose tweet in October, the argument puts forward that “liquidity providers make a mistake, and bleed to temporary loss (IL), but don’t realize it.” The CEO, saying that AMMs exist “because blockchains don’t have the throughput to support order books,” says IL is just a “PC euphemism for doing bad trades.”
IL is when a liquidity provider has a temporary loss of money due to the volatility in a trading pair.
Not a sustainable use case
In its lengthy Twitter thread, SBF finally concludes that “SMPs force you to always make two-sided markets halfway through. That strategy is generally not doing very well. And math, synthetic hedges or whatever doesn’t really help. “
In the meantime, John David Salbego, founder and CEO of Anrkey X praises “the math, algos and original premise” of AMMs, but states that “there is no real use case or sustainability with AMMs in their current state.”
Salbego, who generally shares the same feelings as SBF and Volkov, is also concerned about other issues plaguing SMPs, such as high ETH gas fees, arbitrage, market price fluctuations and the risk of not filling. Unsurprisingly, IL is cited as another hurdle, as Salbego explains:
“I also think having control over your IL is another big challenge to hold back this technology, but I see some cool projects working on solutions that seem really promising.”
However, other players such as Viacheslav Akhmetov, the blockchain leader at Mercuryo.io, remain hopeful about his prospects. Akhmetov points out that the concept of “SMP is still emerging and many new things can be introduced.”
Others think that using a different blockchain can yield better results. Still, they recognize that the current popularity of the Ethereum blockchain makes switching between chains difficult.
What do you think about the role of SMPs? Share your thoughts in the comments below.
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