CoW AMM — The Next Frontier of AMM Innovation

“LVR contributes hundreds of millions of dollars in annual losses to LPs, making it THE decisive factor driving the development of AMM innovation, and that’s not just our opinion. A recent post by Blockworks Research states that “Loss versus rebalancing (LVR) is arguably the biggest (application layer) problem for DeFi on Ethereum. Traditional AMMs are inefficient, and for the next generation of AMMs, the alpha of AMM design is LVR.”

What is LVR?

Automated Market Makers provide one pivotal DeFi function: they allow users to trade tokenized assets on an immutable, trust-minimized, smart contract-powered decentralized exchange. The specific logic (invariant or curve) in which these assets trade depends on the AMM utilized. LVR, or Loss Versus Rebalancing, is a critical bi-product of all current AMM designs.

Every time a swap occurs on a DEX, the price of the underlying assets changes, isolated within the specific pool that facilitates the swap. This means that assets within different LP positions trade at slightly different prices to one another, and it’s this deviation in asset prices gives rise to a (currently) integral part of AMM design known as arbitrage trading. Arbitrage traders are economically incentivized users who scope out the same asset with different prices in different markets. These traders buy assets at a stale or ‘undervalued’ price in one market and then sell them to a separate market that values the asset higher.

However, it’s intuitive to note that for any profit, there must also be losses — not everyone can win. With only two participants in an AMM (traders and LPs), it becomes apparent that the liquidity providers incur these losses. Loss Versus Rebalancing can be thought of as a type of passive opportunity cost LPs incur vs constantly updating stale prices within the pool. The reason that LVR occurs is that external arbitrage traders harness an asymmetry of information, they can scour across multiple markets in real-time, find stale prices, and front-run swaps unbeknownst to LPs who have no option but to take the other side. So, is there a solution?

CoW DAO

Before we unveil CoW AMM, it’s important to note the two products that formed a flourishing solver network and cemented the CoW team’s expertise in MEV mitigation.

CoW Swap is a Meta DEX aggregator that uses Coincidences of Wants (CoWs) to allow users to swap tokens using gasless orders that are settled peer-to-peer, or into any on-chain liquidity source while providing protection from MEV. Coincidences of Wants (CoWs) can be explained as “an economic phenomenon where two parties each hold an item the other wants, so they exchange these items directly.” CoW Swap facilitates CoWs among traders and their orders by using batch auctions as a core mechanism. CoW Protocol’s network of solving algorithms known as “solvers” scans each batch for Coincidences of Wants and competes to find the best liquidity source for user trades across all decentralized exchanges and aggregators.

So far, CoW Swap has facilitated over $44B in swaps and collected over $238M in price surplus for users.

MEV Blocker provides users with personal protection from front-running and sandwich attacks for a broad spectrum of Ethereum transactions. MEV Blocker is a special RPC endpoint that ensures users’ trades are protected from MEV. It does this by sending transactions to a network of searchers that scan for back-running opportunities but cannot frontrun or sandwich your trades.

Leveraging the established solver network, and MEV mitigation expertise that CoW DAO has built, CoW AMM aims to solve one of the “biggest problems for DeFi” — LVR.

CoW AMM

Rather than utilizing traditional swap fees as Liquidity Provider revenue, CoW AMM eliminates LVR by leveraging its extensive solver network and utilizing batch auctions to send surplus to LPs.

The CoW AMM is a special kind of automated market maker designed to help liquidity providers capture MEV from arbitrageurs, rather than swap fees. According to research by Andrea Canidio and Robin Fritsch in the paper “Arbitrageurs’ profits, LVR, and sandwich attacks: batch trading as an AMM design response,” the most promising way to capture LVR is by using batch auctions to rebalance liquidity pools based on surplus.

Rather than utilizing traditional swap fees as Liquidity Provider revenue, CoW AMM eliminates LVR and sends swap ‘surplus’ to LPs. CoW AMM does this via batching trades together, executing all the orders in a batch at the same uniform clearing price. Solvers then compete with each other for the right to trade against the AMM, with the winning solver moving the AMM curve highest.

This mechanic means that CoW AMMs do not offer up stale quotes to external arbitragers since a competitive batch auction determines the pricing. It is the FIRST-ever AMM model that minimizes LVR by capturing arbitrage value for LPs and shielding it from MEV bots. In other words, CoW AMM is a special kind of AMM designed to help liquidity providers capture MEV from arbitrageurs as a yield source, rather than swap fees.

The process works as follows:

1. LPs deposit tokens into protected CoW AMM liquidity pools, where solvers can access the liquidity
2. Rather than traditional traders rebalancing the pool, solvers bid to rebalance CoW AMM pools whenever there is an arbitrage opportunity
3. The solver that offers the most surplus to the pool wins the right to rebalance the pool
4. CoW AMM eliminates LVR by capturing arbitrage value for LPs and shielding it from MEV bots

CoW AMM has already showcased its PMF with contracts being live for the past few months, however, the current implementation lacks several features now standard in most AMMs, such as easy liquidity pooling, incentive structures, data tooling, and an effective user interface for portfolio monitoring.

Leveraging Balancer

“Balancer brings years of experience building world-class AMMs and will contribute this expertise to the design of CoW AMMs.”

For over three years, Balancer Technology has been at the forefront of Automated Market Maker (AMM) innovation. Besides in-house developed weighted and boosted pools, Balancer powers a wide array of DeFi projects, including Gyroscope’s E-CLPs, Cron Finance’s TWAMMs, Fjord’s LBPs, and Xave’s FX markets, simplifying the development process for builders across the ecosystem. The Balancer DAO has extensive expertise in bringing AMMs to market, and this collaboration between Balancer and CoW DAO can potentially establish CoW AMM as the dominant LVR-resistant AMM design.

Creating a Balancer / CoW AMM pool requires giving the CoW Protocol settlement contract (and, by extension, its solvers) exclusive or privileged access to some Balancer pools. The CoW Protocol settlement contract trades with the pool at zero fee, but the in and out amounts are determined in the solver competition. The solver that offers the most surplus to the pool wins the right to rebalance the pool.

CoW AMM will seamlessly integrate into the Balancer front-end with its own dedicated pool page offering a streamlined UX experience for users. Users’ liquidity data will also be integrated into the Balancer portfolio page to ensure efficient portfolio tracking.

Launch Pools

Since volatility dictates the amount of LVR in any given liquidity pool, CoW AMM pools are most effective for volatile token pairs. In fact, research in 2023 showed that CoW AMM returns would have equaled or outperformed CF-AMMs for 10 of the 11 most liquid nonstable pairs. With this in mind, multiple CoW AMM LPs will be seeded with liquidity and incentives on 08/08/24.

The strategic partnership that was agreed between BalancerDAO and CowDAO also includes liquidity and incentive structures for initial launch pools, all details can be found here. The full list of launch pools is as follows:

• USDC/WETH
• BAL/WETH
• COW/WETH
• MKR/WETH
• ARB/WETH
• AAVE/WETH
• GNO/WETH

Looking to the future

Via integrating with Balancer, Cow AMM instantly leverages the experience and collective knowledge that the Balancer team has in bringing AMMs to market. This includes technical features such as liquidity pooling, portfolio data tracking, and frontend interface, but it also includes the incentive structure and network of DAO relations and protocol partners the Balancer DAO has built over the past 4 years. CoW DAO, in return, brings a brand new product to Balancer that paves the way for the stage of AMM innovation — MEV mitigation.

Balancer and Cow DAO share an aligned vision to make DeFi accessible to anyone. LVR reduction has long been thought of as the holy grail of AMM design at Balancer, and we are incredibly excited to join forces with CoW AMM to make this a reality.

Building together > Building alone.