Automated Market Maker (AMM) Overview
An Automated Market Maker (AMM) is a decentralized exchange mechanism that automatically provides liquidity within a protocol. Instead of using a traditional order book, AMMs rely on mathematical formulas and liquidity pools containing token reserves to facilitate trades. Although AMMs may not match the efficiency of limit order books, they guarantee the availability of liquidity, allowing traders to execute orders against these reserves.
Liquidity providers (LPs) in an AMM earn a 25 basis point (bps) fee from every trade that fills their position, with an additional 5 bps directed to the Insurance Fund.
nftperp AMM
The nftperp AMM utilizes a range-concentrated approach, focusing liquidity between a lower bound (α) and an upper bound (β). This range ensures that liquidity is concentrated where it’s most needed. However, due to the volatility of asset prices (e.g., an asset trading at 1 ETH today might reach 100 ETH in the future), setting a fixed range that adapts to price fluctuations without compromising the benefits of concentration is challenging.
To address this issue, nftperp introduces AMM Pools. Each trading pair has multiple AMM pools, with the lower bound of each pool corresponding to the upper bound of the previous one. The upper bound is set as a percentage (R) larger than the lower bound, typically between 3–6%, a range commonly used by Uniswap V3 LPs.
For example, if the initial mark price of an NFT is 33 ETH, and it lies within the range of Pool 35 (32.5 to 37.5 ETH), this pool becomes the active pool. If someone initiates a 20 ETH long position, 14.5 ETH will be matched in Pool 35, driving the price up to 37.5 ETH. The remaining 5.5 ETH will be matched in Pool 36, moving the price to 40 ETH and making Pool 36 the new active pool. The active pool can continue to shift if the trade size is significant enough.
How to Provide Liquidity on nftperp
Providing liquidity (LPing) on nftperp is similar to other concentrated liquidity AMMs. To start, an LP selects a trading pair and defines a range by setting a minimum and maximum price. The LP then decides on the amount of WETH or leverage to be used. As the mark price of the underlying asset fluctuates, the composition of the position will adjust accordingly:
- Delta Neutral Position: When the mark price is at the center of the range, the LP’s position will consist of an equal balance of long and short impermanent positions, resulting in a delta-neutral position relative to WETH.
- Position Changes as Price Moves: If the mark price moves above the center, the position gradually shifts to an impermanent short. If it exits the range, the position converts entirely to a short, which turns into a market order upon withdrawal, leaving the LP with an open short position.
- Long Position: If the mark price drops below the center, the position converts to an impermanent long. Exiting the range leads to a full long position, which also converts to a market order upon withdrawal, resulting in an open long position for the LP.
Providing concentrated liquidity is a high-risk, high-reward strategy. Narrower ranges are more capital-efficient and can generate significant fee income when the mark price stays within the range. However, tighter ranges also carry a higher risk of impermanent loss, especially when the price moves out of the defined range, forcing LPs to take on directional positions. LPs on n
