The CTO of Ripple demystifies the trading strategy the upcoming XRP Ledger (XRPL) automated market maker (AMM) can leverage for profit.
Ripple’s CTO, David Schwartz, has simplified the concept of Automated Market Makers (AMMs) and their profitable trading strategies. AMMs utilize price volatility to generate financial gains, and Schwartz’s explanation helps demystify the underlying principles.
The recent remarks further underscore David Schwartz’s enthusiasm for the eventual launch of the XRP Ledger’s native AMM. As The Crypto Basic reported two months back, Schwartz previously emphasized that the AMM is the most exciting feature to grace the XRPL in the past decade.
The Ripple CTO recently took to Twitter to demystify how AMMs, such as the one coming to the XRP Ledger (XRPL), leverage price volatility.
For those who want to understand an AMM's trading strategy and may find the math too complex to follow, here's a grossly oversimplified way to understand how the trading strategy works:
Say you have an asset that's volatile but no signifcant long-term trend. That is, its price…
— David "JoelKatz" Schwartz (@JoelKatz) June 1, 2023
Schwartz highlighted that AMMs excel when an asset observes marked volatility but retains its overall trend. The strategy involves buying when the price is low and selling when it is high, capitalizing on the average positive movement despite temporary fluctuations.
The concept involved is that even though the price may go up and down, the average movement is often positive, as the asset’s overall trend remains intact. This means that, on average, profit is made by buying low and selling high.
However, Schwartz emphasized that the strategy works best when one asset in the trading pair has a fixed price while the other asset observes volatile price swings. Reacting to this, XRP community member Molly Elmore asked if XRP could serve as the asset with a fixed price.
The XRPL AMM is Not Limited to Specific Asset Pairs
In response, Schwartz clarified that AMMs are not limited to specific asset pairs. They can be created between any two assets, although the mathematical properties of the trading strategy differ when both tokens exhibit volatility. Nonetheless, AMMs remain generally successful in such cases.
No. You can create AMM instances between any two assets. The trading strategy has somewhat different mathematical properties if both assets are volatile (like, say, a BTC/XRP AMM). But it's still interesting and generally quite good.
— David "JoelKatz" Schwartz (@JoelKatz) June 2, 2023
To illustrate the concept further, Schwartz presented a hypothetical scenario. Instead of opting for an XRP/USD AMM, where USD remains stable, an investor bullish on both XRP and Bitcoin (BTC) can choose an XRP/BTC AMM. This approach allows them to benefit from the upward price movements of both assets.
In the example provided, if XRP and BTC double in price, an XRP/USD AMM yields a worst-case scenario of around 40%. In contrast, an XRP/BTC AMM could yield a worst-case scenario of 100%. However, it is essential to balance the AMM correctly and rebalance it when necessary for optimal results.
Schwartz stressed that considering risks is crucial. If the investor’s bullish forecast is incorrect, resulting in a 50% decrease in XRP and BTC prices, the worst-case loss for an XRP/USD AMM would be approximately 30%. In contrast, an XRP/BTC AMM would entail a 50% loss. Thus, XRP/USD is considered safer, while XRP/BTC exhibits higher volatility.