An overview of oracle-reliant market makers

The Block Research has recently explored different decentralized spot exchange (DEX) and perpetual futures exchange designs. Most of them are automated market makers (AMMs) that bootstrap passive liquidity from liquidity providers (LPs). LPs combine idle assets to market-make and earn trading fees from market takers. Most AMMs rely on mathematical formulae to algorithmically set the mid-price (the average of bid and ask prices) and the market depth based on the asset quantities in the liquidity pools. 

For example, in Uniswap v2 and its forks, a liquidity pool consists of two assets. The mid-price is set as the ratio of the asset quantities in the pool. If there are 10 ETH and 20,000 USDC in an ETH/USDC liquidity pool, the exchange rate would be $2,000. On the other hand, they adopt a “constant product invariant” that parametrizes the shape of the market depth, as shown below. For a detailed overview of how pricing algorithms are used in AMMs, see this research piece.