How Does the Lack of a Central Order Book on an Automated Market Maker (AMM) DEX Change the Nature of Front-Running?
Traditional front-running involves exploiting knowledge of a pending order on a central order book. AMM DEXs, however, use liquidity pools and mathematical formulas to determine asset prices, not an order book.
Front-running on an AMM is a "sandwich attack" where the attacker places a buy order just before a large user's buy and a sell order immediately after. The attacker profits from the price impact caused by the victim's trade, exploiting the AMM's pricing formula rather than a bid/ask spread.
Glossar
Pricing Formula
Derivation ⎊ A pricing formula within cryptocurrency derivatives establishes a quantitative relationship between an option’s theoretical value and underlying asset characteristics, incorporating volatility, time to expiration, and prevailing interest rates.
Central Order Book
Nexus ⎊ The term Central Order Book, within cryptocurrency derivatives, options trading, and broader financial derivatives contexts, signifies a consolidated, electronically managed marketplace where buy and sell orders for contracts are matched.
Constant Product Market Maker
Invariant ⎊ Constant Product Market Makers represent a deterministic function within automated market making, establishing a price relationship between assets based on the product of their quantities; this foundational principle ensures liquidity is continuously available, albeit subject to impermanent loss.
Price Impact
Momentum ⎊ The concept of price impact, particularly within cryptocurrency markets and derivatives, fundamentally reflects the immediate effect of a trade on an asset's price.
Liquidity Pool
Mechanism ⎊ A liquidity pool functions as an incentivized counterparty in decentralized finance, aggregating capital from multiple participants to facilitate trading without traditional intermediaries.
Automated Market Maker
Architecture ⎊ Automated Market Makers (AMMs) represent a paradigm shift in decentralized exchange, employing mathematical formulas to determine asset prices and facilitate trading without traditional order books.