CoW DAO, the decentralized autonomous organization that helped build CoW Swap, is launching a MEV-capturing automated market maker for liquidity providers called CoW Automated Market Maker (AMM).
The CoW AMM is intended to solve the “loss versus rebalancing” (LVR) or “leverage” problem faced by liquidity providers (LP).
Most AMMs today rely on information from other exchanges to determine the market price of an asset. This means that there may be a discrepancy between the prices quoted on the AMM and those on the exchange.
Opportunistic traders often use this opportunity to arbitrage the AMM, causing LPs to lose value. LVR in this case is defined as the loss that LPs have to suffer due to the rebalancing of liquidity pools by arbitrage bots.
According to Andrea Canidio, senior research analyst at CoW Swap and author of the research paper Arbitrageurs' Profits, LVR, and Sandwich Attacks, LVR is now a major centralizing force.
“This is the main reason for the current concentration in the block builder market, where three builders create more than 70% of the blocks and have great control over which transactions are included in the blockchain,” Canido said.
In fact, research from Cornell University suggests that LPs on major token pairs earn less than 5-7% of their deposits due to LVR. Arbitrators account for an estimated $500 million in LP losses each year, becoming a driving factor affecting liquidity provision in the decentralized finance space.
CoW AMM is designed to turn the competition into arbitrage liquidity pools that give LPs an advantage.
“In constant function AMMs, arbitrageurs compete to be higher in a block, and the first arbitrageur rebalances the pool at the worst possible price for the LPs.” In CoW AMM, however, solvers compete for the right to rebalance the pool, by offering better and better prices to its LPs,” he said.
After a liquidity provider deposits tokens into a CoW AMM liquidity pool, these funds become accessible to CoW swap traders. The solvers then compete to process trades via CoW Swap and offer to rebalance the AMM pools whenever an arbitrage opportunity arises.
The solver that offers the largest surplus is able to rebalance the pool, protecting LPs from MEV bots.
Anyone can contribute liquidity to the CoW AMM via programmatic orders. To start, the CoW DAO has allocated 6 million COW and 139 WETH to increase the liquidity of the COW/WETH market.
Fernando Martinelli, CEO of Balancer Labs, noted in a press release reviewed by Blockworks that MEV/LVR is a key issue currently preventing LPs from joining AMMs.
“We at Balancer are very excited to explore custom AMM designs like CoW AMM,” he added.
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