A CFAMM is a traditional AMM model popularized by Uniswap. The protocol was first inspired by a Reddit post written by Vitalik.
The price curve for these AMMs abides by the x*y=k equation, where X and Y are the quantities of assets 1 and 2, and K is a constant.
- Users have to deposit equal dollar amounts of each asset into a pool.
- The nature of this bonding curve ensures that an LPs exposure is always 50:50 in either asset.
- When the dollar value of asset X increases relative to Y, a portion of asset X will have to be sold for Y to maintain the pool balance of 50:50. This is balanced by arbitrageurs.
For an in-depth example of how a pricing curve works check this tool out.
Since constant product AMMs determine asset prices on their own, they rely on arbitrageurs for efficiency. The downside of this is that these AMMs are not very efficient. In a constant product AMM, two assets are always bonded to each other, with their corresponding dollar values always equally split 50/50. In the real world, asset liquidity doesn’t work this way; it is much more flexible.
The x*y=k price curve effectively guarantees liquidity at any price from just above 0 to infinity. This isn’t ideal, because liquidity provision at the long tails of the price distribution curve will see little to no utilization.
