AMM vs. PMM: Pros and cons of different market-making mechanisms

In the cryptocurrency market, the rise of decentralized exchanges (DEXs) has led to the development of various market-making mechanisms, with Automated Market Makers (AMM) and Proactive Market Makers (PMM) being two prominent models. These mechanisms differ in liquidity provision, capital efficiency, and user experience. Below is a comparative analysis:

AMM (Automated Market Maker)

AMMs use smart contracts and liquidity pools to provide quotes automatically, eliminating the need for traditional order books. Examples include Uniswap and Curve.

Pros :

• Decentralized: Operates without intermediaries, relying solely on algorithms, reducing trust costs.
• User-Friendly: Allows anyone to add or remove liquidity easily, ideal for small-scale traders.
• Constant Liquidity: Assets in the pool remain tradable even during market volatility.

Cons :

• Impermanent Loss: Liquidity providers may incur losses during price swings.
• Low Capital Efficiency: Funds are underutilized, especially when prices deviate significantly.
• Slippage Issues: Large trades often face price slippage, increasing costs.

PMM (Proactive Market Maker)

PMMs optimize liquidity by dynamically adjusting price curves, combining algorithms with proactive intervention. DODO is a notable example.

Pros :

• High Capital Efficiency: Adjusts liquidity based on demand, minimizing idle capital.
• Low Slippage: Actively manages large trades to reduce slippage, enhancing user experience.
• Reduced Impermanent Loss: Improved pricing mechanisms lower risks for liquidity providers.

Cons :

• High Complexity: Requires advanced algorithms and maintenance, raising technical barriers.
• Centralization Risk: Partial reliance on proactive intervention may introduce manipulation concerns.
• Limited Adaptability: May underperform AMMs in extreme market conditions.

AMM vs. PMM Comparison

Conclusion

AMMs excel in simplicity and decentralization, making them ideal for retail users and early-stage markets. PMMs, with their focus on capital efficiency and trading optimization, cater to professional users seeking enhanced performance. The choice between AMM and PMM depends on project goals and market dynamics.