Excitement within the XRP community continues to grow as Ripple CTO, David Schwartz, sheds light on the profit potential that traders and liquidity providers can tap into through the forthcoming XRP Ledger (XRPL) Automated Market Maker (AMM).
This development stems from the widely anticipated XLS-30D proposal, a longstanding initiative aimed at introducing an AMM to the XRPL.
Schwartz recently offered valuable insights in response to an elaborate thread by Lewis Jackson, a prominent figure in the XRP community, who attempted to explain the mechanics of the upcoming XRPL AMM but fell short on profitability details due to various factors at play.
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Schwartz highlighted a fascinating invariant that traders could leverage within the AMM, provided there are no bugs in its code. As he had previously explained, AMM’s trading strategy comes into play when a trader adds two assets, such as XRP and dollars, to a shared pool for trading. In return, they receive Liquidity Provider (LP) tokens representing their contribution to the pool.
The native design of the XRPL AMM ensures that traders can always redeem these LP tokens for a quantity of both assets that, when multiplied, equal the original value of the assets they initially deposited in the liquidity pool.
There is an interesting invariant. Assuming no bugs in the code, for a balanced contribution to the pool, you are guaranteed you can redeem your LP tokens for an amount of both assets whose product is equal to, or greater than, the product of the amounts you contributed. 1/2
— David "JoelKatz" Schwartz (@JoelKatz) August 2, 2023
Schwartz further clarified this concept with an example, considering a hypothetical scenario where XRP is being traded at $0.50 per token.
Suppose a trader adds 10 XRP (each valued at $0.50) and $5 to the liquidity pool to acquire LP tokens. When redeeming these tokens, the resulting product of the XRP and dollars should always be greater than or equal to 50.
Additionally, the algorithm backing this system continually strives to increase the overall value of the assets in the pool, ensuring that the product of their quantities never diminishes. This guarantees traders the ability to recoup at least the value of their initial contribution if not more.
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While the XRP Ledger AMM presents immense profit potential, there are complexities to consider. Jackson rightfully pinpointed the challenges in estimating precise yields from the AMM due to market conditions, trading volume, asset pairs, and fee structures.
Adhering to Jackson’s concerns, Molly Elmore raised the issue of impermanent loss, which liquidity providers may experience when the value of deposited assets fluctuates while in the liquidity pool.
To engage effectively with the XLS-30D AMM, traders must be cognizant of this risk and carefully evaluate their risk tolerance.
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