PropAMMs: The Bold New Players in Decentralized Liquidity Management

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In the world of decentralized finance (DeFi), traditional automated market makers (AMMs) have often been criticized for their passive liquidity provision that leads to adverse selection. However, recent research by Ozan Solmaz, Lioba Heimbach, and Jason Milionis highlights a revolutionary approach called proprietary automated market makers (propAMMs), which are changing the game in liquidity management across multiple blockchain platforms.

The Rise of PropAMMs

First emerging on the Solana blockchain in 2024, propAMMs have matured into significant players, capturing over half of the SOL/USDC trading volume by 2026. Unlike traditional AMMs, which update their prices only after a trade occurs, propAMMs are designed to actively manage liquidity by continuously repricing their quotes based on market conditions, allowing them to respond swiftly to fluctuations in fair value.

Key Findings from the Research

The longitudinal study conducted by the authors spans a full year and involves essential insights into how propAMMs outperform their passive counterparts. One striking result reveals that just two seconds after a transaction, propAMMs earn an average profit of 0.37 basis points (bps) on Solana and 1.19 bps on Base, while traditional AMMs incur losses of 0.22 and 0.62 bps, respectively.

This advantage is attributed to several factors:

  • Frequent Price Updates: By updating their quotes without a trade, propAMMs ensure they provide fresher, more competitive prices.
  • Counterparty Risk Management: PropAMMs can adjust their pricing based on the type of user interacting with them, effectively charging higher fees for riskier trades.
  • Avoiding Arbitrage Losses: These market makers are less affected by arbitrage mechanisms since they continuously adjust their prices, making it harder for arbitrageurs to profit at the expense of liquidity providers.
  • Spoofing Tactics: PropAMMs can set a quote higher than the actual fill price, allowing them to benefit from market movements while capturing profits from transaction fees.

Implications for Retail Traders

Interestingly, propAMMs appear to cater better to retail users. The research indicates that propAMMs offer significantly better prices for uninformed traders compared to AMMs. For instance, retail flow on propAMMs pays only 0.26 bps in fees on Solana, while AMMs charge 2.59 bps, underscoring how propAMMs might democratize access to more favorable trading conditions.

The Future of Liquidity Provision

This groundbreaking study sheds light on a potentially transformative shift in how decentralized liquidity is managed. With propAMMs becoming increasingly dominant through advanced pricing mechanisms, they may set new standards for both user experience and overall market efficiency in the DeFi space.

In summary, the research by Solmaz, Heimbach, and Milionis not only illustrates the operational advantages of propAMMs but also emphasizes the vital role they could play in shaping the future of liquidity provision in decentralized markets.

Authors: Ozan Solmaz, Lioba Heimbach, Jason Milionis

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