Dec 10 2022
AMMs
Bit of a lazy post, but here is a blog post I enjoyed today. Learned about the mechanics of CFMMs like Uniswap, how Robinhood makes money, and more. Below are some interesting excerpts:
The general principle is this: the Uniswap thesis works best when the two assets are mean-reverting. Think a pool like USDC/DAI, or WBTC/TBTC — these are assets that should exhibit minimal impermanent loss and will purely accrue fees over time.
So Uniswap works really well for certain pairs and terribly for others.
But it’s hard not to notice that almost all of the top Uniswap pools so far have been profitable! In fact, even the ETH/DAI pool has been profitable since inception.
You see, all market making is a battle against two kinds of order flow: informed flow, and uninformed flow. Say you’re quoting the BTC/USD market, and a fat BTC sell order arrives. You have to ask yourself: is this just someone looking for liquidity, or does this person know something I don’t?
As a market maker, you make money on the uninformed flow. Uninformed flow is random — at any given day, someone is buying, someone is selling, and at the end of the day it cancels out. If you charge each of them the spread, you’ll make money in the long run. (This phenomenon is why market makers will pay for order flow from Robinhood, which is mostly uninformed retail flow.)