The Case for Stochastically Dynamic AMMs

Abstract

AMMs represent a class of decentralized exchange mechanisms that rely on a fixed mathematical formula to price assets. Popular AMM protocols utilize a constant function approach which is deterministic in design. However, these designs are plagued with issues such as impermanent loss, slippage costs, and market risk incomputability. More specifically, the design allows professional arbitrage traders to siphon off value from liquidity providers. We would like to make the case for the development of a new class of AMM designs based on stochastic pricing that would dynamically adjust to market information. The stochastic design would function like a profit maximizing market maker which we could solve through optimal control theory.