Automated Market Making and Loss-Versus-Rebalancing

2022/08/11 by Jason Milionis, Milionis, Jason, Ciamac C. Moallemi +5 · 37 citations
Decision Sciences · Economics, Econometrics and Finance · #Auction Theory and Applications #Banking stability, regulation, efficiency #FOS: Economics and business #FOS: Mathematics #Financial Markets and Investment Strategies #Mathematical Finance (q-fin.MF) #Optimization and Control (math.OC) #Portfolio Management (q-fin.PM) #Pricing of Securities (q-fin.PR) #Trading and Market Microstructure (q-fin.TR)

paper · pdf · doi:10.48550/arxiv.2208.06046

openalex publication_date 2022/08/11 · openalex created_date 2025/10/10 · openalex updated_date 2026/07/28

Abstract

We consider the market microstructure of automated market makers (AMMs) from the perspective of liquidity providers (LPs). Our central contribution is a ``Black-Scholes formula for AMMs''. We identify the main adverse selection cost incurred by LPs, which we call ``loss-versus-rebalancing'' (LVR, pronounced ``lever''). LVR captures costs incurred by AMM LPs due to stale prices that are picked off by better informed arbitrageurs. We derive closed-form expressions for LVR applicable to all automated market makers. Our model is quantitatively realistic, matching actual LP returns empirically, and shows how CFMM protocols can be redesigned to reduce or eliminate LVR.

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