The recently launched Automated Market Maker (AMM) functionality on the XRP Ledger (XRPL) has introduced a new wrinkle to the ecosystem. While AMMs offer exciting opportunities for liquidity provision and decentralized trading, a lack of experience among users appears to be causing unintended consequences.
Understanding Single-Sided Deposits
AMM pools rely on liquidity providers depositing equal value of two assets to function effectively. A liquidity provider for an XRP/USDC pool would ideally deposit both XRP and USDC in a balanced ratio. However, current user behavior on the XRPL AMM favors single-sided deposits, particularly with XRP. This means users are flooding the pools with XRP without a corresponding inflow of USDC.
Read Also: Ripple CTO Clarifies Potential Impact of AMM On XRP Price Volatility
This trend disrupts the intended equilibrium within the pool. An abundance of XRP relative to USDC pushes the price of XRP down within the pool, creating an arbitrage opportunity. However, capitalizing on this opportunity can be challenging due to limited USDC availability.
A recent example shared by Neil Hartner (@illneil) on X highlights this issue. On March 22, a liquidity provider deposited a significant amount of XRP into the XRP/USDC pool. This single-sided deposit caused a drastic price drop for XRP within the pool.
A keen trader identified the arbitrage opportunity and swapped $80 for a staggering 1,869 XRP, effectively acquiring XRP at $0.0428. XRP was trading around $0.63 at the time.
⚠️ WARNING: Be very cautious with single-sided deposits into AMM pools that don't have a lot of assets yet. This 2000 XRP deposit caused the rate on the pool to get heavily skewed, allowing someone to arbitrage the pool by swapping 80 USD for 1869 XRP. pic.twitter.com/bqQP3qtI4a
— Neil Hartner (@illneil) March 22, 2024
While this trade generated significant profit for that investor, it comes at a cost to liquidity providers in the pool. To maintain balance, the XRPL AMM automatically adjusts the price to reflect the new ratio of assets. Consequently, other XRP holders in the pool witnessed a decrease in their holdings. One user revealed in the comments that his 500 XRP had been reduced to 427 XRP.
Ripple CTO Weighs in on Single-Sided Deposits
David Schwartz, Chief Technology Officer (CTO) of Ripple, has acknowledged the potential benefits and drawbacks of single-sided deposits. He recognizes that this feature simplifies the user experience by removing the need to acquire two separate assets. However, he cautioned that it can significantly influence price dynamics, especially in pools with lower liquidity.
Read Also: Ripple CTO Reveals How XRP Holders Can Earn Passive Income With XRP
Schwartz advised users to leverage available tools to assess the potential price impact before executing a transaction. He also recommended that developers show this information on their user interfaces to aid investors in decision-making.
A crypto expert recently predicted that XRP could drop to $0.1 because of the AMM, and these problems have increased the worry that XRP might decline. Encouraging responsible use of single-sided deposits and understanding their impact on pool dynamics could aid the long-term health of the XRPL AMM.
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