AMMs might Die

No product has done more for DeFi than the AMM. A simple yet elegant design that provided the world’s first-ever permissionless liquidity layer. Onchain liquidity is at risk of something we all know and despise: permissions.

AMMs operate on a non-discriminatory basis. Every trader is treated the same and priced using the same bonding curve. This can be inefficient because, in reality, not all order flow is equal.

For example, an order routed through the CoWSwap auction is much less likely to be an arbitrage than a swap submitted through a private bundle to a block builder. These “filtered” transactions are often called “non-toxic” flow, and they’re what make Market Makers profitable. Private Market Makers (PMMs), unlike AMMs, have much better tools and information to attract this non-toxic flow while rejecting toxic flow.

Auction designs themselves even tend to favor Private Market Makers, who don’t need to worry about slippage invalidating a submitted solution or estimating the volatile gas cost of swaps.

PMMs are outcompeting AMMs in filling intent-based volume. We see their market share growing as a result.

Liquidity will leave AMMs as order flow shifts to an intent-based model.

Over time AMMs will lose liquidity to more permissioned (and profitable) styles of market making, causing a cascading effect where DeFi loses its permissionless liquidity layer, leaving the only way to trade through middlemen.

DeFi is shifting to an intent-based model, and intent-based models are favoring PMMs.

Building MEV-Resistance without cutting the balls from the Bull

MEV-resistant design in AMMs is a broad and diverse topic. It boils down to one inadmissible fact: AMMs are inherently blind to offchain data that is necessary for accurate pricing.

Many solutions “cut the balls off the bull” by locking onchain liquidity and only opening it up through offchain filters. These options are the safest at first glance, but they change the operational workflow of trading onchain by enshrining middlemen between traders and liquidity. Some of these solutions can be described as:

1. Auctioning off the right to reprice the pool, and returning arbitrage profits to LPs (see mcAMM).

2. Forgetting the AMM, and relying on offchain price discovery using Frequent Batch Auctions. (good primer on FBAs for discretized uniform clearing price)

3. Permissioned sequencing or pre-filtering of AMM transactions, intended to stop ordering attacks that extract value from LPs.

These solutions significantly alter the swap transaction workflow and often REQUIRE signatures from offchain operators to work. This is a slippery slope that can compromise the original goal of an accessible liquidity layer not censorable by third-party externalities.

While we recognize the efficacy of these designs, we fear they inherently shift away from critical foundational properties of DeFi.

A Hybrid Solution

Hybrid Order Type (HOT) is an MEV-resistant AMM that can permissionlessly expose liquidity to any trader with a good conscience. It does not welcome toxic flow; it wins non-toxic flow.

With HOT, onchain and offchain price expression can be combined onto a single pool of liquidity. Permissionless AMMs are no longer in direct competition with offchain permissioned market-making systems.

Uniquely on Valantis, liquidity can be shared across multiple order types and market-making logic, meaning we can adapt to the growing world of offchain liquidity quoting while maintaining the vital mission to preserve the durability of natively accessible onchain liquidity during this paradigm shift.

LPs in HOT Pools are exposed to two systems of market-making that are described as follows:

(1) Onchain AMM Quoting

This Module implements a UniV3 range order with a dynamic fee. The Manager contract can provide the AMM with periodic offchain price information to keep prices fresh and spreads low. The dynamic fee increases spread when the likelihood of arbitrage is high and keeps them at a minimum when it is low.

Today, the dynamic fee is set by the Arrakis Network, which uses a set of offchain data sources. Stale-price fees can be configured using any set of data sources and predictive models, some more decentralized, some more centralized. Regardless, at swap time the AMM is exposed to any actor who wishes to transact via an unfiltered mempool.

There are additional onchain checks to prevent a malicious/unprofitable AMM state update.

(2) Offchain Network Quoting

LPs are exposed to offchain quoting strategies which may have varying permissions, logic, and trust assumptions. All of which can be measured against onchain price sources like oracles to prevent malicious activity.

Today, Arrakis runs proprietary market-making strategies on behalf of LPs, connecting to known sources of non-toxic flow like Solvers in Order Flow Auctions via the Valantis RfQ API. Arrakis uses the complete flexibility of their offchain strategies to quote Solvers based on their perceived toxicity using markouts, transaction origin, and other commonly understood tools in payment for order flow.

Onchain checks ensure offchain quotes do not deviate significantly from onchain prices and liquidity is not over-committed in a single trade. This is a very similar security model to Arrakis’ current PALM products on Uniswap v3. Arrakis also announced their plans to decentralize their Market Making infrastructure via a Symbiotic AVS, the Arrakis Network.

This architecture ensures that DeFi native LPs can re-capture the “non-toxic” flow previously stolen by PMMs, while still exposing liquidity to unfiltered traders.

Putting it all together and taking it back apart

We have a single pool of capital, market making according to two systems.

DeFi is built upon principles of composability, so of course, the HOT Liquidity Module is designed modular with multiple modes - where a developer can choose to integrate only one, both, or neither system of market-making.

The core philosophy of HOT stays the same.

• Offchain pricing is increasingly becoming important in DeFi, stepping outside of onchain constraints reveals much more nuanced information about the world. We must recognize this, while opening up the access to DeFi native LPs.

• Onchain pricing needs protections in the dark forest. But we must do it in a way that keeps AMMs open and sovereign.

Putting these concepts together, LPs maximize their exposure to non-toxic flow and minimize their exposure to toxic flow.

We are live, kind of

Today, the Arrakis-managed implementation of HOT is live with private liquidity, settling significant volume on CoWSwap in the most competitive pairs in DeFi. Soon, this pool will be opened to the public, allowing anyone to provide liquidity and earn yield without losing precious returns to MEV and Private Market Makers.

Prospective developers can build on top of HOT with new offchain networks or additional Valantis Modules (Sovereign Vault for shared liquidity, custom swap fees, etc.). Any new AMM built using HOT can have out-of-the-box MEV-agnosticism with minimal effort, in addition to any number of unique features that are only possible on Valantis.

Permissionless pool deployments will open up soon. All communication regarding future developments will be communicated on our X account.