Expiring Assets in Automated Market Makers

TL;DR

This paper introduces a novel decentralized exchange design for expiring assets, combining AMMs and limit-order books to handle risks and price adjustments near expiration.

Contribution

It formally describes a new DEX model for expiring assets, addressing arbitrage limitations and risk management in AMMs.

Findings

Ensures market clearance and liveness for expiring assets.

Provides mechanisms for liquidity providers to control risk.

Enables dynamic price adjustments when arbitrage fails.

Abstract

An automated market maker (AMM) is a state machine that manages pools of assets, allowing parties to buy and sell those assets according to a fixed mathematical formula. AMMs are typically implemented as smart contracts on blockchains, and its prices are kept in line with the overall market price by arbitrage: if the AMM undervalues an asset with respect to the market, an "arbitrageur" can make a risk-free profit by buying just enough of that asset to bring the AMM's price back in line with the market. AMMs, however, are not designed for assets that expire: that is, assets that cannot be produced or resold after a specified date. As assets approach expiration, arbitrage may not be able to reconcile supply and demand, and the liquidity providers that funded the AMM may have excessive exposure to risk due to rapid price variations. This paper formally describes the design of a decentralized exchange (DEX) for assets that expire, combining aspects of AMMs and limit-order books. We ensure liveness and market clearance, providing mechanisms for liquidity providers to control their exposure to risk and adjust prices dynamically in response to situations where arbitrage may fail.