Background
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As an integral part of the decentralized finance (DeFi) ecosystem, DEX with AMM protocols have gained massive traction. Instead of matching the buy and sell sides, AMMs employ a peer-to-pool method to determine asset price algorithmically through conservation function, which encodes a desired invariant property of the system.
A common AMM constant value is not affected by trades (if we don’t take into consideration the trading fees) — it is only affected by the pool liquidity changes. The internal exchange rate is a function of the current amount of the tokens in the pool and can significantly differ from the external market exchange rates.
AMM algorithms help stabilize the ratio of two pool tokens with different market prices as their quantities change due to trader swaps within the liquidity pool. AMM algorithms are also used to set the prices of tokens for pool transactions. Each time a swap is made, the token values change in the underlying pool. Arbitrage bots automatically identify gaps from the tokens’ market prices and conduct additional swaps to quickly reestablish stable market prices.
Dynamic Curve Mechanism changes the parameters of the conservation function with any changes in asset amounts in the pool or oracle prices outside the pool, so that the internal exchange rate automatically adjusts to be equal to the Oracle price without any divergence loss. However, in this method, there is also no room for arbitrageurs to trade and change the balance of the pool assets to bring the internal exchange rate closer to the external Oracle price.
As a result, there could possibly be a significant shortage or surplus in certain tokens, thus increasing the liquidity provider’s impairment loss.
IMM stands for Flype’s Interoperable Market Maker mechanism, which computes the value of the LP tokens based on their underlying asset’s Oracle price and pool reserves. The IMM actively adjusts the LP tokens’ exchange rates in order to incentivize arbitrageurs to perform trades that will guide the pool’s asset quantities to equilibrium.
This unique mechanism significantly reduces divergence loss for liquidity providers as compared to common AMMs.