Centaur Swap: Using Arbitrageurs To Reduce Slippage
The rise of Decentralised exchanges (DEX) and Automated Market Makers (AMMs) have opened amazing opportunities for traders who are looking to make a quick profit from the cryptocurrency industry. One such opportunity created by AMMs is that of arbitrage.
In today’s article, we will explore how Centaur uses arbitrage to its advantage to reduce slippage on Centaur Swap.
What is Arbitrage and Why Does It Occur?
Arbitrage or Arbitrage Trading is the process of buying a financial asset from one market and selling it on another financial market, thereby profiting from the price difference.
For example, if Ethereum is trading at $1,800 on Binance but is trading at $1,790 on Coinbase, an arbitrage trader can buy Ethereum from Coinbase and sell it on Binance, for a $10 instant profit.
Arbitrage occurs because of market inefficiencies. Each exchange has its traders, market makers and trading pairs against different currencies.As a result, the markets are not able to simultaneously update the asset price resulting in price differentiation.
Arbitrage trading is a very common form of trading in the traditional finance market and it is considered a low-risk form of trading.
One downside of arbitrage trading is that, for the trade to be profitable the difference should be higher than the trading fee involved. Going back to our previous example of Coinbase and Binance, if Binance charges a fee of $15 on the transaction, the arbitrage trade becomes a loss-making trade. Another downside of arbitrage is that that price difference only exists for a short period because arbitrageurs will come in to correct such pricing inefficiencies
Arbitrage in DeFi
Traders on decentralised exchanges take advantage of the possibility of high slippage on the platform to make arbitrage profits.
As previously explained in our article on liquidity maximisation, slippage is the price difference between the external (CEX) price of an asset and internal (AMM) price of an asset. Slippage occurs due to the design of an AMM to prevent a liquidity pool from being drained completely by a large order.
During times of high slippage, traders on decentralised exchanges do not trade until the price corrects itself while traders looking for arbitrage opportunities can find good deals. These opportunities exist until slippage reduces and the market corrects itself. Unfortunately, it’s a slow process and can take a while for the market to correct itself, causing potential revenue loss for liquidity providers.
Centaur believes that the arbitrageurs can be incentivised to speed up the correction process while also ensuring that there is no revenue loss for the liquidity providers.
How Centaur Swap Uses Arbitrage To its Advantage
Centaur Swap uses single-side staking to provide liquidity. In single-side staking, a liquidity provider only needs to stake a single-asset rather than in the pair-based format that is seen on popular AMMs, where an LP needs to stake a pair of tokens in equal value to provide liquidity to a pool.
Whenever a trader swaps from one asset to another on Centaur Swap, a surplus and deficit are created.
To understand this, let us use an example. There are two pools in Centaur Swap — Token A pool and Token B pool. If a trader exchanges token B for token A, the pool goes into an imbalanced state — Pool A has fewer token A, and Pool B has more token B. Due to the design of the curve, a larger portion of liquidity is concentrated when the pool current balance of the pool (the number of tokens it currently holds) is the same as the target balance of the pool (the total amount deposited by liquidity providers).
Centaur uses a discount/premium model to incentivise arbitrageurs to rebalance the pool. Whenever a pool’s token holding drops or increases after trade execution, Centaur Swap applies a relevant discount and surplus on the pools to rebalance them.
And since the Centaur Swap relies on single side staking, an arbitrageur can quickly make use of the arbitrage opportunity unlike in current AMMs where a trader would be exposed to price fluctuations induced by slippage.
Going back to our previous example, Centaur swap would apply a discount on Token B to encourage arbitrageurs to take Token B and a premium on Token A to encourage arbitrageurs to put in more Token A, thus rebalancing the liquidity pools.
This mechanism is effective as it incentivises the arbitrageurs to rebalance the pool from its current balance to a target balance as quickly as possible. Through a combination of these methods, Centaur Swap reduces and manages slippage considerably.
This mechanism of incentivising arbitrageurs to quickly rebalance the pool is one such innovation that is part of Centaur Swap. You can read more on how Centaur Swap manages the liquidity efficiently by going through the Centaur Swap Whitepaper.
By combining the best elements of decentralised finance with measured regulatory control, Centaur is bridging DeFi and traditional finance. For more information, please take a look at our website or join our Telegram community discussion group and announcement channel.
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