The Pricing And Hedging Of Constant Function Market Makers
Cryptography and Security
2023-06-21 v1 Pricing of Securities
Abstract
We investigate the most common type of blockchain-based decentralized exchange, which are known as constant function market makers (CFMMs). We examine the the market microstructure around CFMMs and present a model for valuing the liquidity provider (LP) mechanism and estimating the value of the associated derivatives. We develop a model with two types of traders that have different information and contribute methods for simulating the behavior of each trader and accounting for trade PnL. We also develop ideas around the equilibrium distribution of fair price conditional on the arrival of traders. Finally, we show how these findings might be used to think about parameters for alternative CFMMs.
Keywords
Cite
@article{arxiv.2306.11580,
title = {The Pricing And Hedging Of Constant Function Market Makers},
author = {Richard Dewey and Craig Newbold},
journal= {arXiv preprint arXiv:2306.11580},
year = {2023}
}