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AMM
DeFi Strategies • Yield Models • Token Income
algorithmic liquidity pool system
Automated Market Maker — AMM
An AMM is a decentralized trading system that allows users to swap tokens without a traditional order book. Instead of matching buyers and sellers directly, an AMM uses algorithmic liquidity pools — where users deposit token pairs — and prices are determined by mathematical formulas (like constant product: x * y = k). AMMs let anyone be a liquidity provider and earn fees, helping power the backbone of DeFi.
Use Case: AMMs allow tokens to be traded instantly and permissionlessly, enabling DEXs and yield farming strategies across multiple blockchain ecosystems.
Key Concepts:
- Liquidity Pool — Pooled token reserves that enable decentralized trading
- Token Pair — Two assets combined in equal value to create tradeable liquidity
- Swap Fee — Transaction fee paid by traders and distributed to liquidity providers
- Impermanent Loss — Temporary value divergence when providing liquidity in volatile pairs
- Constant Product Formula — Mathematical algorithm (x * y = k) that determines swap prices
- Yield Farming — Strategy of providing liquidity across AMMs to maximize returns
- LP Tokens — Receipt tokens representing your share of a liquidity pool
- Slippage Risk — Price impact from trade size relative to pool depth
- Decentralized Exchange — Trading platforms built on AMM infrastructure
- DeFi Risk — Smart contract and protocol risks in AMM participation
- Smart Contracts — Self-executing code powering AMM mechanics
- Automated Market Makers — Broader category of algorithmic trading systems
- Structural Alpha — Returns from AMM inefficiencies and mechanics
- DeFi Yield Models — Income structures including LP fee revenue
Summary: AMMs revolutionized DeFi by replacing centralized order books with algorithmic liquidity pools. They enable permissionless trading, democratize market-making, and create passive income opportunities for anyone willing to provide liquidity — making decentralized exchanges accessible, efficient, and resilient.
How AMMs Work
the mechanics of algorithmic trading
Deposit
Pool
Swap
Earn
Step 1: Provide Liquidity
• Deposit two tokens in equal value
• Example: $1000 ETH + $1000 USDC
• Receive LP tokens as receipt
• Your share of pool is recorded
• Becomes tradeable liquidity
• Deposit two tokens in equal value
• Example: $1000 ETH + $1000 USDC
• Receive LP tokens as receipt
• Your share of pool is recorded
• Becomes tradeable liquidity
Step 2: Pool Formation
• All deposits combine into pool
• Pool has total reserves (x, y)
• Constant product: x * y = k
• k remains constant during swaps
• Price derives from ratio
• All deposits combine into pool
• Pool has total reserves (x, y)
• Constant product: x * y = k
• k remains constant during swaps
• Price derives from ratio
Step 3: Traders Swap
• Trader wants ETH, provides USDC
• USDC added to pool reserves
• ETH removed from pool reserves
• Price shifts based on formula
• Larger trades = more slippage
• Trader wants ETH, provides USDC
• USDC added to pool reserves
• ETH removed from pool reserves
• Price shifts based on formula
• Larger trades = more slippage
Step 4: LPs Earn Fees
• Each swap charges fee (0.3% typical)
• Fees added to pool reserves
• LPs earn proportional share
• Compound over time
• Withdraw anytime with LP tokens
• Each swap charges fee (0.3% typical)
• Fees added to pool reserves
• LPs earn proportional share
• Compound over time
• Withdraw anytime with LP tokens
The Math: If a pool has 100 ETH and 200,000 USDC, k = 20,000,000. ETH price = 2000 USDC. If someone buys 10 ETH, they must add enough USDC to maintain k. This formula ensures there’s always liquidity—but price moves with each trade.
AMM Platforms by Network
major protocols across ecosystems
Ethereum
• Uniswap — Pioneer, largest TVL
• SushiSwap — Community fork
• Curve — Stablecoin specialist
• Balancer — Multi-asset pools
• 1inch — Aggregator
• Uniswap — Pioneer, largest TVL
• SushiSwap — Community fork
• Curve — Stablecoin specialist
• Balancer — Multi-asset pools
• 1inch — Aggregator
Flare & Songbird
• SparkDEX — Primary DEX
• BlazeSwap — Alternative
• Enosys — Multi-chain
• Cyclo.Finance — Yield focus
• Growing ecosystem
• SparkDEX — Primary DEX
• BlazeSwap — Alternative
• Enosys — Multi-chain
• Cyclo.Finance — Yield focus
• Growing ecosystem
XRPL
• Built-in AMM — Protocol-level
• No smart contract risk
• Integrated with native DEX
• Unique auction slot mechanism
• Low fees, fast settlement
• Built-in AMM — Protocol-level
• No smart contract risk
• Integrated with native DEX
• Unique auction slot mechanism
• Low fees, fast settlement
Other Networks
• BNB: PancakeSwap, Venus
• Solana: Raydium, Orca
• Polygon: QuickSwap
• Arbitrum: Camelot, GMX
• Every major chain has AMMs
• BNB: PancakeSwap, Venus
• Solana: Raydium, Orca
• Polygon: QuickSwap
• Arbitrum: Camelot, GMX
• Every major chain has AMMs
Network Considerations: Choose AMM platforms based on the chain where your assets reside, gas costs, liquidity depth, and security track record. XRPL’s protocol-level AMM offers unique security advantages—no smart contract risk at all.
AMM Types and Formulas
different mathematical approaches
Evolution: AMMs have evolved from simple constant product to sophisticated designs. Concentrated liquidity (Uniswap V3) improved capital efficiency but requires active management. StableSwap minimizes slippage for like-assets. Each design involves trade-offs between simplicity, efficiency, and impermanent loss.
Providing Liquidity: Risks and Rewards
what LPs actually experience
Rewards
• Swap Fees — 0.05-1% per trade
• Protocol Incentives — Token rewards
• Yield Farming — Stack multiple rewards
• Capital Efficiency — Assets working
• Passive Income — Automated earning
• DeFi Composability — LP tokens usable
• Swap Fees — 0.05-1% per trade
• Protocol Incentives — Token rewards
• Yield Farming — Stack multiple rewards
• Capital Efficiency — Assets working
• Passive Income — Automated earning
• DeFi Composability — LP tokens usable
Risks
• Impermanent Loss — Price divergence cost
• Smart Contract Risk — Code vulnerabilities
• Rug Pulls — Malicious projects
• Low Volume — Insufficient fee revenue
• Token Risk — Paired asset collapse
• Gas Costs — Entry/exit expenses
• Impermanent Loss — Price divergence cost
• Smart Contract Risk — Code vulnerabilities
• Rug Pulls — Malicious projects
• Low Volume — Insufficient fee revenue
• Token Risk — Paired asset collapse
• Gas Costs — Entry/exit expenses
Best Pools
• Stablecoin pairs (low IL)
• High-volume pairs
• Blue-chip assets
• Audited protocols
• Established platforms
• Stablecoin pairs (low IL)
• High-volume pairs
• Blue-chip assets
• Audited protocols
• Established platforms
Riskier Pools
• Volatile/meme tokens
• Low liquidity pairs
• New, unaudited AMMs
• Extreme APY promises
• Unknown projects
• Volatile/meme tokens
• Low liquidity pairs
• New, unaudited AMMs
• Extreme APY promises
• Unknown projects
IL Mitigation
• Correlated pairs
• Concentrated ranges
• IL protection protocols
• Fee accumulation > IL
• Time in pool
• Correlated pairs
• Concentrated ranges
• IL protection protocols
• Fee accumulation > IL
• Time in pool
Reality Check: Most retail LPs underperform simply holding. Impermanent loss, gas costs, and complexity often eat into returns. For sustainable yield without LP risk, consider alternatives like Kinesis Holder’s Yield—real revenue, zero IL, no smart contract exposure.
Impermanent Loss Explained
the hidden cost of liquidity provision
What Is Impermanent Loss
• Loss vs holding tokens separately
• Occurs when prices diverge
• “Impermanent” until you withdraw
• Becomes permanent on exit
• The bigger the price move, the worse
• Can exceed fee earnings
• Loss vs holding tokens separately
• Occurs when prices diverge
• “Impermanent” until you withdraw
• Becomes permanent on exit
• The bigger the price move, the worse
• Can exceed fee earnings
The Math (Simplified)
• Prices stay same: 0% IL
• 1.25x price change: 0.6% IL
• 1.5x price change: 2.0% IL
• 2x price change: 5.7% IL
• 3x price change: 13.4% IL
• 5x price change: 25.5% IL
• Prices stay same: 0% IL
• 1.25x price change: 0.6% IL
• 1.5x price change: 2.0% IL
• 2x price change: 5.7% IL
• 3x price change: 13.4% IL
• 5x price change: 25.5% IL
Minimize IL
• Stablecoin pairs
• Correlated assets
• Short time frames
• High-fee pools
• Narrow ranges (V3)
• Stablecoin pairs
• Correlated assets
• Short time frames
• High-fee pools
• Narrow ranges (V3)
Accept IL If
• Fees > expected IL
• Bullish on both tokens
• Protocol incentives high
• Strategic positioning
• Long-term commitment
• Fees > expected IL
• Bullish on both tokens
• Protocol incentives high
• Strategic positioning
• Long-term commitment
Avoid IL Entirely
• Single-sided staking
• Kinesis Holder’s Yield
• Lending protocols
• Liquid staking
• Yield aggregators
• Single-sided staking
• Kinesis Holder’s Yield
• Lending protocols
• Liquid staking
• Yield aggregators
The Truth: Impermanent loss is the reason many LPs lose money. If ETH 2x’s while you’re providing ETH/USDC liquidity, you’d have been better off just holding ETH. Fee income must exceed IL for LPing to be profitable. Calculate carefully before committing.
AMM Strategies for Different Users
matching approach to goals and skills
Conservative LP Strategy
• Stablecoin pairs only
• Top-tier protocols (Uniswap, Curve)
• Minimal IL exposure
• Accept lower APY
• Focus on fee income stability
• Example: USDC/USDT on Curve
• Stablecoin pairs only
• Top-tier protocols (Uniswap, Curve)
• Minimal IL exposure
• Accept lower APY
• Focus on fee income stability
• Example: USDC/USDT on Curve
Active LP Strategy
• Concentrated liquidity (V3)
• Active range management
• Higher capital efficiency
• Requires monitoring
• Higher skill, higher potential
• Example: ETH/USDC tight range
• Concentrated liquidity (V3)
• Active range management
• Higher capital efficiency
• Requires monitoring
• Higher skill, higher potential
• Example: ETH/USDC tight range
Yield Farmer Strategy
• Stack LP fees + incentives
• Auto-compound with Beefy
• Multiple reward tokens
• Chase highest yields
• Accept higher risks
• Requires active rotation
• Stack LP fees + incentives
• Auto-compound with Beefy
• Multiple reward tokens
• Chase highest yields
• Accept higher risks
• Requires active rotation
Zero-AMM Strategy
• Skip LP complexity entirely
• Kinesis for passive yield
• Liquid staking (stETH, sFLR)
• No IL, no LP management
• True passive income
• Better risk-adjusted for most
• Skip LP complexity entirely
• Kinesis for passive yield
• Liquid staking (stETH, sFLR)
• No IL, no LP management
• True passive income
• Better risk-adjusted for most
Honest Assessment: AMM liquidity provision is complex and often unprofitable for retail. Professional market makers and bots capture most value. For sustainable passive income without LP risks, Kinesis Holder’s Yield delivers real revenue without impermanent loss, smart contract risk, or active management.
AMM Participation Checklist
before providing liquidity
Before Depositing
☐ Understand impermanent loss
☐ Calculate realistic fee income
☐ Research protocol security
☐ Check audit status
☐ Verify TVL and volume
☐ Assess token pair risk
☐ Understand impermanent loss
☐ Calculate realistic fee income
☐ Research protocol security
☐ Check audit status
☐ Verify TVL and volume
☐ Assess token pair risk
Choosing Pools
☐ High volume (more fees)
☐ Established protocol
☐ Reasonable IL risk
☐ Sustainable incentives
☐ Exit liquidity available
☐ Gas costs factored in
☐ High volume (more fees)
☐ Established protocol
☐ Reasonable IL risk
☐ Sustainable incentives
☐ Exit liquidity available
☐ Gas costs factored in
Position Management
☐ Monitor performance
☐ Track IL vs fees earned
☐ Know when to exit
☐ Claim rewards regularly
☐ Rebalance if needed
☐ Document for taxes
☐ Monitor performance
☐ Track IL vs fees earned
☐ Know when to exit
☐ Claim rewards regularly
☐ Rebalance if needed
☐ Document for taxes
The Principle: AMMs democratized market-making but didn’t eliminate complexity or risk. If you provide liquidity, do it informed—understand IL, choose pools carefully, and monitor positions. For truly passive income without LP complexity, consider Kinesis Holder’s Yield or liquid staking derivatives instead.