How Does a Constant Product Market Maker (CPMM) Model Create Arbitrage Opportunities?
A CPMM, like the one used by Uniswap V2, maintains a constant product x y = k, where x and y are the quantities of the two assets in the pool. When a trade occurs, the ratio of x and y changes, which in turn changes the asset price.
If a trade on the CPMM causes the price to deviate from the price on other exchanges, an arbitrage opportunity is created. Arbitrageurs exploit this temporary price difference to profit and bring the pool's price back in line with the broader market.
Glossar
CPMM
Mechanism ⎊ Constant Product Market Makers (CPMMs) represent a specific automated market maker (AMM) design, fundamentally altering liquidity provision within decentralized exchanges.
Constant Product
Invariant ⎊ The core principle dictates that the product of the quantities of the two assets in a liquidity pool remains constant, represented mathematically as $x cdot y = k$, where $x$ and $y$ are the reserves of the two tokens.
Cpmm Formula
Formula ⎊ The Constant Product Market Maker (CPMM) formula, a cornerstone of automated market making (AMM) protocols, fundamentally governs the exchange of assets within decentralized exchanges.
Constant Product Market Maker (CPMM)
Formula ⎊ The Constant Product Market Maker (CPMM) operates on the fundamental invariant formula x y = k, where x and y represent the quantities of two assets in a liquidity pool, and k is a constant value.