AMM-based DEX on the XRP Ledger (2312.13749v4)

Abstract: Automated Market Maker (AMM)-based Decentralized Exchanges (DEXs) are crucial in Decentralized Finance (DeFi), but Ethereum implementations suffer from high transaction costs and price synchronization challenges. To address these limitations, we compare the XRP Ledger (XRPL)-AMM-Decentralized Exchange (DEX), a protocol-level implementation, against a Generic AMM-based DEX (G-AMM-DEX) on Ethereum, akin to Uniswap's V2 AMM implementation, through agent-based simulations using real market data and multiple volatility scenarios generated via Geometric Brownian Motion (GBM). Results demonstrate that the XRPL-AMM-DEX achieves superior price synchronization, reduced slippage, and improved returns due to XRPL's lower fees and shorter block times, with benefits amplifying during market volatility. The integrated Continuous Auction Mechanism (CAM) further mitigates impermanent loss by redistributing arbitrage value to Liquidity Providers (LPs). To the best of our knowledge, this study represents the first comparative analysis between protocol-level and smart contract AMM-based DEX implementations and the first agent-based simulation validating theoretical auction mechanisms for AMM-based DEXs.

• The paper demonstrates that the XRPL-AMM, leveraging a Continuous Auction Mechanism, outperforms Ethereum-based AMMs by reducing fees, slippage, and impermanent losses.
• It employs a game-theoretic analysis to evaluate transaction metrics and liquidity provider returns, emphasizing the benefits of protocol-level integration on the XRP Ledger.
• The results imply that integrating AMMs on XRP can enhance arbitrage opportunities and set the stage for future innovations in decentralized finance.

Automated Market Maker on the XRP Ledger: An Overview

The paper "Automated Market Maker on the XRP Ledger" presents a detailed investigation into the development and evaluation of an Automated Market Maker (AMM) on the XRP Ledger (XRPL). This research is motivated by the limitations observed in Ethereum-based AMMs, such as high transaction costs, significant slippage, impermanent losses, and synchronization issues. The XRPL-AMM is posited as a solution that leverages XRPL's rapid transaction capabilities and introduces a Continuous Auction Mechanism (CAM) to improve price synchronization with external markets.

Key Aspects and Methodology

The XRPL-AMM is designed to be integrated at the protocol level of the XRP Ledger, which is notable for its swift and low-cost transactions. The authors compare the performance of XRPL-AMM against Ethereum-based AMMs, especially Uniswap, which holds a dominant market share in decentralized exchanges (DEXs). The research employs a game-theoretic approach to analyze the performance metrics of the AMM, focusing on parameters such as slippage, impermanent loss, arbitrageur profits, and LP returns.

Performance Evaluation

The XRPL-AMM demonstrates superior performance in several key areas:

1. Price Synchronization: The XRPL-AMM, with its shorter block interarrival time and low network fees, shows enhanced capability in synchronizing prices with external markets compared to its Ethereum-based counterparts. The introduction of the CAM encourages arbitrage activities that facilitate efficient price alignment.
2. Transaction Costs and Slippage: Transaction costs on the XRPL-AMM are significantly reduced due to the XRPL's low transaction fees. This reduction leads to lower slippage for arbitrageurs, offering a more favorable trading environment than that of Uniswap, particularly under varying market conditions.
3. Arbitrage and Liquidity Provider Considerations: The paper introduces two strategies for the XRPL-CAM: one benefiting liquidity providers (XRPL-CAM-A) and another favoring arbitrageurs (XRPL-CAM-B). The integration of the CAM turns market volatility into an opportunity for arbitrageurs and thus enhances LP returns by harnessing the resultant arbitrage-driven trading volume.
4. Volatility Adaptation: Under different volatility scenarios, the XRPL-AMM consistently outperforms Uniswap in maintaining minimal price deviations from the external market benchmark. The findings suggest that the XRPL-AMM can effectively capitalize on high market volatility to improve liquidity provision dynamics.

Implications and Future Directions

The paper's findings advocate for the XRPL-AMM's potential to transform decentralized finance (DeFi) ecosystems by offering a more efficient alternative to current AMM implementations. The enhanced performance of the XRPL-AMM in slippage reduction, arbitrage efficiency, and liquidity provider returns underscores its utility in addressing the drawbacks of Ethereum-based AMMs.

From a theoretical perspective, this paper enriches the understanding of integrating AMMs directly into blockchain protocols, setting a foundation for further exploration of protocol-level AMM solutions. Practically, the research suggests broader implications for DeFi scalability and efficiency, which are crucial for widespread adoption.

Future research could build on these insights by exploring advanced features such as dynamic fee structures, enhanced security protocols against MEV, and further integration with decentralized applications (DApps). Additionally, empirical analysis involving real-world data would further validate the XRPL-AMM's performance and adaptability across diverse market conditions.

In conclusion, the XRPL-AMM represents a significant advancement in the DeFi sector, promising to leverage the inherent advantages of the XRP Ledger to create an efficient, sustainable financial ecosystem.