Arbitrageurs' Profits, LVR, and Sandwich Attacks: FM-AMM Design Response

Główne pojęcia

The authors propose a novel Function Maximizing AMM design to eliminate arbitrage profits and sandwich attacks in decentralized finance.

Streszczenie

The study introduces the FM-AMM design to address issues of arbitrage profits and sandwich attacks in decentralized finance. It compares the returns of providing liquidity on Uniswap v3 with the simulated FM-AMM across various token pairs. The paper highlights the importance of batch trading to prevent price manipulation and discusses implications for traditional finance.
The CFAMMs are criticized for trading at a loss during rebalancing events, leading to arbitrageurs exploiting liquidity providers. Sandwich attacks are also identified as a common issue in CFAMMs. The study proposes that an FM-AMM can eliminate these problems by processing trades in batches and using uniform prices.
Competition between arbitrageurs ensures that the batch always trades at equilibrium price, eliminating arbitrage profits and sandwich attacks. The paper empirically analyzes the return on providing liquidity to Uniswap v3 compared to the simulated FM-AMM for different token pairs.
The research suggests that an FM-AMM could be beneficial for traditional finance applications due to increased efficiency and security. It also discusses how fees impact trading strategies on the FM-AMM and emphasizes the importance of batching trades to maintain price consistency.

Statystyki

"Between October 2022...approximately 1.2 billion USD"
"Currently, top three builders produce approximately 80% of blocks added to Ethereum blockchain"

Cytaty

Kluczowe wnioski z

Arbitrageurs' profits, LVR, and sandwich attacks

by Andrea Canid... o arxiv.org 02-29-2024

https://arxiv.org/pdf/2307.02074.pdf

Głębsze pytania

How might traditional financial markets benefit from adopting an FM-AMM design?

In traditional financial markets, the adoption of a Function-Maximizing Automated Market Maker (FM-AMM) design could bring several benefits. Firstly, FM-AMMs eliminate arbitrage profits and sandwich attacks, which are significant issues in decentralized finance and blockchain design. By removing these inefficiencies, traditional financial markets can experience increased liquidity provision efficiency and reduced opportunities for exploitation by traders.
Secondly, FM-AMMs offer a more efficient market mechanism compared to Constant Function AMMs (CFAMMs). CFAMMs trade at a loss during rebalancing events due to discriminatory pricing rules. In contrast, FM-AMMs process trades in batches with uniform prices, ensuring that all trades within a batch pay the same price. This leads to fairer pricing for all participants and reduces the potential for front-running or other manipulative strategies.
Additionally, by maximizing an objective function based on liquidity reserves rather than maintaining constant product functions like CFAMMs do, FM-AMMs encourage passive investment strategies among liquidity providers. This approach can attract more LPs looking for stable returns without being exposed to unnecessary risks associated with volatile trading environments.

How can blockchain technology improve market efficiency beyond addressing arbitrage issues?

Blockchain technology offers several ways to enhance market efficiency beyond addressing arbitrage issues. One key improvement is through transparency and immutability provided by blockchain ledgers. All transactions recorded on the blockchain are transparent and tamper-proof, reducing fraud and enhancing trust among market participants.
Smart contracts on blockchains enable automated execution of predefined terms once specific conditions are met. This automation streamlines processes such as trade settlements, reducing delays and human errors while increasing operational efficiency in trading activities.
Decentralized Finance (DeFi) platforms built on blockchains provide access to global markets 24/7 without intermediaries or centralized authorities. This democratization of finance allows users worldwide to participate in various financial activities seamlessly while minimizing costs associated with traditional banking systems.
Moreover, tokenization of assets using blockchain technology enables fractional ownership of high-value assets like real estate or art pieces. This fractional ownership increases liquidity in traditionally illiquid asset classes while providing investors with diversified investment opportunities across different asset types.

What potential challenges could arise from implementing batch trading in AMMs?

Implementing batch trading in Automated Market Makers (AMMs) may introduce some challenges:

Latency Issues: Batch processing requires collecting orders over time before executing them simultaneously. Latency between order submission and execution can lead to discrepancies if prices fluctuate significantly during this period.

Complexity: Managing batches effectively requires sophisticated algorithms that prioritize orders based on various factors like size or timing.

3 .Scalability Concerns: As transaction volumes increase, handling large batches efficiently becomes challenging due to computational limitations.
4 .Risk Management: Aggregating multiple trades into batches increases risk exposure if one large trade negatively impacts the entire batch's performance.
5 .Regulatory Compliance: Regulators may require additional oversight when implementing batch trading mechanisms due to concerns about fairness and transparency.