Introducing Maverick’s Game-changing Automated Liquidity Placement Mechanism
Automated Liquidity Placement is just one of several groundbreaking features of Maverick AMM, and this blog describes one way it can be used. Read our full explanation of Maverick AMM to understand how ALP is part of the most intelligent and versatile AMM in DeFi, offering LPs a much greater variety of options for managing their liquidity.
In November 2021, Maverick Protocol launched a perpetual market testnet. We followed this in April 2022 with our swap market testnet. Both testnets feature our innovative Automatic Liquidity Placement (ALP) mechanism — the secret weapon that enables users to enjoy higher capital efficiency in Maverick-powered AMMs.
Higher capital efficiency is better for everyone: it promotes better prices for traders and therefore more income from trading fees for LPs.
In this post, we will explain how Maverick can offer users better liquidity and pricing through this proprietary ALP mechanism. In order to do this, we’ll first take a quick look at how DEXs have historically attempted to address issues surrounding liquidity and slippage, and then discuss how Maverick’s mechanism improves on these systems.
Current Automated Market Makers in DeFi
DeFi is essentially built on Automated Market Makers (AMMs), the smart contracts that enable trading to be decentralized, permissionless, and immediate. AMMs manage pools of capital contributed by liquidity providers (LPs), with the contract itself acting as the counter-party to traders.
Most AMMs use some variation of Uniswap V2’s constant product formula. Based on the simple formula xy = k, this is essentially a computational rule that states that the value of k must remain constant within every trading pool. If x and y represent the two assets being traded in a pool, then the rule effectively states that whenever the value of x changes the value of y must also be changed in order to keep k, their product, constant (and vice versa).
For example, imagine a user wishes to trade in Uniswap’s ETH/USDT pool, at a point when the liquidity of the pool is at 1 ETH and 3,000 USDT. If x is the amount of ETH in the pool and y the amount of USDT, then the k for this pool is 3,000 (because 10 * 3,000 = 3,000). Whatever interactions the user has with the pool, the AMM would always have to keep the k at 3,000.
This formula can be represented on a graph as an invariant curve (so named because it is the curve produced by the formula which has the constant or invariant product k).
While this is a practical tool for automating price discovery in a smart contract, it also inevitably introduces slippage into the trading experience.
Put most simply, slippage is when the price a trader pays is different from the price they see in a pool. This occurs in constant product AMMs because the constant product formula must adjust the price of every incoming trade in order to keep k constant. In our example, the constant product k must stay at 3,000, regardless of how much ETH or USDT is added to or removed from the pool.
Uniswap V3 set out to solve the V2 slippage problem by introducing concentrated liquidity: LPs could now choose to concentrate their liquidity in custom price ranges and earn fees from any swaps that take place within that range. If the swap price moves outside of an LP’s defined bucket, they cease to earn fees until such time as the swap price returns to the range or until they reallocate their liquidity.
We can immediately appreciate the difference between V2 and V3 by comparing the two graphs below:
The graph on the left is the familiar invariant curve created by the AMM in V2 that automatically distributes liquidity within a pool in order to preserve the constant value of k. The graph on the right represents notional liquidity distribution in V3, with liquidity concentrated by LPs within a certain zone. This concentration of liquidity flattens a section of the curve into a constant slope, along which the price of y remains stable (compared to the invariant curve). Traders can effectively make swaps on this slope with low-to-zero slippage.
While this is definitely good news for traders, Uniswap V3 also creates more work for LPs, who need to reallocate their liquidity constantly so as to track the current swap price. If not, they risk losing out on fees from trades that occur outside their designated range, while traders may find the market thinning as the pool price moves.
Poor liquidity concentration is not a theoretical problem: there are many Uniswap V3 pools where liquidity is severely misallocated.
MAV Automated Liquidity Placement
A Maverick ALP AMM solves all of these problems by concentrating liquidity natively and dynamically in the pool, eliminating the requirement that LPs constantly reallocate their own liquidity. In other words, Maverick automates liquidity concentration. As a result, traders benefit from less slippage and LPs enjoy greater capital efficiency and less active liquidity management overhead.
ALP uses an innovative mechanism based on the swap orders placed by traders, using those orders as a signal of when to move the liquidity distribution. As traders swap and move the price, this is a reliable signal that the intrinsic value of the asset is moving as well. In this case, the liquidity distribution should likewise also move to support the new price range.
Accordingly, the Maverick ALP mechanism shifts liquidity in each pool according to a function of the trade inputs. By moving the distribution, ALP ensures that there will always be a broad base of support around the desired price, meaning lower slippage for traders.
This is equivalent to the AMM automatically moving a constant slope portion of the price curve so that it tracks the price established by swaps. This benefits both LPs and traders, since (as we saw with Uniswap V3) the constant slope represents a zone of low slippage.
What’s Next?
With these built-in liquidity-adjusting dynamics, Maverick offers traders and LPs better performance in terms of both slippage and capital efficiency. An ALP-powered AMM smartly reallocates liquidity to ensure better price support without the need for direct management by LPs. This effectively eliminates the role of arbitrage, in favor of automatic pool management that more directly benefits LPs.
We believe that AMMs powered by Maverick’s ALP will become an essential block in building a more transparent and sustainable DeFi ecosystem. An ALP virtual Automated Market Maker will be the next step on our roadmap, in order to support DeFi derivative players. In the future, we may see more DeFi protocols adopt and build their markets on Maverick’s game-changing ALP mechanism.
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