Multiswap represents a return to sound financial engineering principles in the spirit of the Black-Scholes model. To understand what Multiswap is, and how it works, let's go back to the basics.
What is an AMM?
An AMM is a protocol that maintains a balance between assets and liabilities. It creates a liquidity pool of asset tokens and introduces a pool token liability that mirrors the value of these underlying assets. The system ensures that the total value of assets always equals the total liabilities.
In other words, the AMM is always balanced with the total asset value equal to the total liability value. From this, the AMM imposes a number of constraints that capture elements of supply and demand in order to make a market, i.e. produce prices, for the asset tokens in the pool.
A Rebalancing Portfolio
The first constraint AMMs impose on the portfolio is that the post-trade weight of each asset token in the pool is known and does not depend on the trade. This means that an AMM operates as a rebalancing portfolio. For example, each Uniswap pool is a two-asset portfolio that maintains a 50/50 ratio between its assets. The total value of all Liquidity Provider (LP) tokens at any given time equals the combined value of the two asset tokens.
This constraint allows us to determine the state of the AMM given the weights and reserves of each token. It also lets us calculate the price of each asset based on the reserves of each token and their respective weights.
The Three Principles
Multiswap differentiates itself by enforcing three specific principles:
Value of LP tokens = Value of asset tokens
A pre-specified pool rebalancing strategy
These principles ensure a stable trading environment that benefits both LPs and traders.
1. Value of LP tokens = Value of asset tokens
The first principle stipulates that the value of a pool token must equal the value of all assets in the pool, making it a liability for the assets. This approach focuses on achieving and maintaining an optimal ratio between asset pairs in a liquidity pool.
2. A Pre-Specified Pool Rebalancing Strategy
The second principle means that the post-trade weight of each asset is known before the AMM state changes and does not depend on the trade. This principle involves adjusting asset ratios within a liquidity pool to maintain the desired proportions. Rebalancing also helps mitigate the risk of impermanent loss and ensures that LPs receive a fair return on their investments.
3. Self-Financing Transactions
The third principle declares that no value is created or destroyed in the process of a transaction, but is merely transferred from one token to another. Multiswap's commitment to self-financing transactions guarantees that it can reward LPs fairly and maintain a fair trading environment.