Virtual Automated Market Makers (vAMMs)

Virtual Automated Market Makers (vAMMs) are a variation of the automated market maker (AMM) concept that has gained popularity in the blockchain and decentralized finance (DeFi) space. To understand vAMMs, let’s first explore the foundation of AMMs.

Automated market makers are systems that utilize smart contracts to facilitate token swaps. Liquidity providers supply tokens to the AMM, which are then utilized for token swaps by traders. The prices at which these swaps occur are determined by a mathematical formula, commonly known as the bonding curve. This allows for decentralized and continuous trading without the need for traditional order books.

vAMMs take this concept a step further by expanding the functionality of AMMs to include derivatives, such as perpetual contracts. Unlike traditional AMMs that facilitate the swap of real tokens, vAMMs are designed to swap virtual synthetic assets, specifically derivatives contracts. These contracts represent financial instruments that derive their value from an underlying asset, such as cryptocurrency or traditional assets like stocks or commodities.

It’s important to note that vAMMs themselves do not hold any real assets. Instead, traders can participate in leveraged trades based on collateral stored in a smart contract vault. This collateral is used to back the virtual synthetic assets, allowing traders to gain exposure to the price movements of the underlying assets without actually owning them. The vAMM acts as a bridge between traders and the underlying assets, enabling leveraged trading opportunities.

vAMMs are primarily used for price discovery and leverage management, rather than spot trading. Each trade conducted on a vAMM triggers the calculation of an entry or exit price, similar to how prices are calculated on AMM-style exchanges. These prices are determined based on the prevailing market conditions and the composition of the virtual synthetic assets in the vAMM pool.

First-generation vAMMs relied on fixed formulas for price calculations. However, second-generation vAMMs have introduced a concept called concentrated liquidity design. This design allows liquidity providers to offer leverage, enabling them to provide significantly more liquidity with the same amount of collateral. In other words, liquidity providers can allocate a portion of their collateral to back a larger pool of virtual synthetic assets, thereby increasing the potential trading volume and opportunities on the vAMM.

Let’s take a simple example to illustrate how a vAMM works. Imagine a vAMM that offers leveraged trading on Bitcoin using collateral in the form of Ethereum. A liquidity provider can lock up a certain amount of Ethereum in the vAMM’s smart contract vault. Based on the collateral provided, the vAMM creates virtual synthetic assets representing leveraged long and short positions on Bitcoin. Traders can then interact with the vAMM to buy or sell these virtual synthetic assets, speculating on the price movements of Bitcoin without actually owning any Bitcoin.

The vAMM continuously recalculates the price of the virtual synthetic assets based on the market conditions. When a trader enters or exits a position, the vAMM adjusts the price to reflect the impact of the trade on the overall pool composition. This ensures that traders receive fair prices for their trades and that the vAMM remains balanced.

Yenwen Feng, the author of this article, is a cryptocurrency and technology professional with extensive experience in the blockchain industry. As the co-founder and CEO of Perpetual Protocol, a decentralized perpetual contract protocol, Yenwen has been actively involved in the development and implementation of vAMMs. Perpetual Protocol aims to provide decentralized, trustless, and non-custodial perpetual contracts, allowing traders to gain exposure to various assets with leverage.

In conclusion, virtual Automated Market Makers (vAMMs) are a specialized type of AMMs that facilitate the trading of virtual synthetic assets, particularly derivatives contracts, without the need for traditional order books. They enable leveraged trading opportunities and offer benefits such as price discovery and leverage management. Second-generation vAMMs have introduced concentrated liquidity design to provide enhanced liquidity and trading volume. As the DeFi ecosystem continues to evolve, vAMMs are likely to play a significant role in the development of decentralized derivatives markets.