Background of NFT AMM1. Background of NFT AMM
In the mainstream NFT trading market, the most common method of trading is peer-to-peer, where buyers can either make an offer on the NFT they are interested in or purchase it directly based on the seller's listed price. This type of trading is order book limit order trading. The downside to this method is that sellers can't always make a sale quickly, and if they need to sell their assets quickly, they may have to lower the price, resulting in a loss. To address these issues, NFT AMM was introduced. NFT AMM focuses on liquidity and allows users to become liquidity providers. By participating in the market liquidity, users can earn additional income.
What is AMM?
Automated Market Makers (AMM) are protocols commonly used by decentralized trading platforms to price assets through mathematical formulas. Unlike traditional trading platforms that use the order book method, asset pricing is done through pricing algorithms. The AMM pricing formula varies depending on the protocol. For instance, Uniswap uses the constant product market maker model, which is represented by the formula x * y = k. In this formula, x represents the amount of one token in the liquidity pool, y represents the amount of the other token, and k is a fixed constant indicating that the total amount of liquidity in the pool must remain constant. AMM works similarly to traditional order book trading platforms by setting up trading pairs such as ETH/USDT. However, traders using AMM do not need to trade with a specific counterparty. Instead, they interact with liquidity pools and use algorithms to achieve instant trade.
What is NFT AMM?
NFT AMM is an automated market maker protocol designed specifically for NFTs. It allows any user to become a market liquidity provider, providing the same trading conditions to the NFT market as Defi by improving liquidity for trading NFT collectibles. However, unlike Defi, its liquidity pool consists of NFTs and tokens, enabling users to buy or sell NFTs through the liquidity pool. In contrast to the constant product model of x * y = k used in the traditional Uniswap mode, NFT AMM employs the pricing function model, characterized by linear and exponential curves. In a pool of linear curves, the NFT price will move by a fixed amount delta each time a transaction occurs. In contrast, in a pool of exponential curves, the NFT price is multiplied by a fixed proportional delta each time there is a transaction. The proportional delta is set by the user when creating the flow pool and can not be modified.
What is the advantage of NFT AMM?
Using traditional AMM and NFT AMM modes as examples, the difference between the two pricing models is demonstrated through real data accounting. Typically, the amount of work for a single NFT project is less than 10,000. If the constant product algorithm of Uniswap liquidity pool x * y = z is used, it may result in a large number of sliding prices due to unilateral insufficient liquidity.
1.Traditional AMM (constant product mode with x * y= k)
Suppose we have a liquidity pool consisting of 10 NFTs and 10 ETH, using the constant product algorithm x * y = z, where x represents the number of NFTs, y represents the amount of ETH, and z is a fixed constant, in this case, z=100.
However, if the number of NFTs in the pool decreases significantly due to continuous buying and selling, the price may diverge sharply. For example, if there are only 2 NFTs left in the pool, the purchase price would spike to 50 ETH, whereas with 10 NFTs left in the pool, the purchase price would be 1.111 ETH. Therefore, the use of the constant product algorithm may not be the most effective pricing method for NFTs, where the supply is limited and unique.
2.NFT AMM (Exponential curve)
Here is an example of an exponential curve liquidity pool, consisting of 10 NFTs and 10 ETH, with a delta of 0.1. Each time a transaction occurs, the NFT price is multiplied by 1.1 (1 + delta 0.1).
As a result, when there are 10 NFTs left in the pool, the purchase price is 1 ETH. When there are only 2 NFTs left in the pool, the purchase price only rises to 2.144 ETH, which is a significant decrease compared to the 50 ETH in the previous example. This pricing model provides a narrower range of price fluctuations compared to the traditional AMM (the highest NFT purchase price in the liquidity pool is 2.358 ETH, the highest NFT sale price is 2.358 ETH, the lowest NFT purchase price is 0.386 ETH, and the overall price fluctuation is controlled within 2), making it more suitable for limited NFT market transactions.
What is the liquidity pool?
Liquidity providers (LPs) play a crucial role in the functioning of liquidity pools. Essentially, LPs inject funds into the pool, which serves as a large pool of funds for traders to conduct transactions with. As compensation for providing liquidity to the protocol, LPs earn a commission from the transactions that take place within the pool. In the Defi model, the proportion of earned commissions is uniformly determined by the protocol. However, in the NFT AMM model, the percentage of fees earned is set by the liquidity pool creator. For example, in the case of Uniswap, LPs are required to deposit two equivalent tokens into the liquidity pool, such as 50% ETH and 50% DAI into the ETH/DAI pool. On the other hand, NFT AMM requires LPs to deposit a certain amount of NFT and equivalent tokens into the liquidity fund pool. For instance, an LP could deposit 1 piece of BAYC and 100USDT into the BAYC/USDT fund pool, assuming that the market price of BAYC is 100USDT at that time.
What is the loss of impermanence?
Impermanent loss occurs when the price ratio of the deposited tokens or NFTs changes compared to when they were initially deposited into the pool. The greater the price change, the higher the impermanent loss. While the term "impermanent" implies that the loss may be reduced if the asset recovers to its initial deposit price, it can turn into a permanent loss if funds are withdrawn at a different price ratio than when they were deposited. Therefore, it is recommended that liquidity providers hold onto their tokens instead of depositing them into the pool when the price of tokens or NFTs in the liquidity pool changes significantly.
How do I create an NFT liquidity pool？
To create a NFT liquidity pool, log in to your Gate account and use the NFT AMM functionality. Select the pool type, choose from three options (Buy NFTs with tokens, Sell NFTs for tokens, and trade NFTs to earn fees), and set the liquidity pool parameters, including the percentage of transaction fees charged per transaction, the initial price of the NFT, how the price curve changes, and the proportion of the NFT price changes after each trade.
Next, set the liquidity pool parameters:
- Percentage: The percentage of transaction fees charged per transaction
- Initial price: The initial price of the NFT
- Joint curve: How the price curve changes
- Delta: The proportion of the NFT price changes after each trade
The left half is the setting of price parameters. Reasonable parameter setting is the key to a successful liquidity pool. Set the buy and sell limits, and the protocol will calculate the number of NFTs and tokens to deposit. You can view the cost and benefit of the transaction by looking at the price curve below.
The last step is to select the NFT to be added to the liquidity pool and confirm whether the parameters are set correctly. After the work and funds are reloaded, the creation is successful.
