A breakdown Of Trading Systems
An AMM (Automated Market Maker) and a CLOB (Central Limit Order Book) are both popular mechanisms used in financial markets to facilitate trading, but they operate in fundamentally different ways.
WHAT IS AN AMM (Automated Market Maker)?
Decentralised model: AMMs are commonly used in decentralised exchanges (DEXs), particularly in the context of DeFi (Decentralised Finance).
Liquidity Pools: AMMs rely on liquidity pools where users (liquidity providers) deposit pairs of assets (e.g., ETH/USDT). The AMM algorithm automatically sets prices based on the ratio of assets in the pool.
Pricing: Prices are determined algorithmically, often using a formula like the constant product formula: x \times y = k , where x and y are the quantities of two assets and k is a constant. No direct matching of buyers and sellers occurs.
Slippage and impermanent loss: Traders may experience price slippage when executing large orders due to changes in the asset ratio. Liquidity providers also face the risk of impermanent loss (when one asset appreciates or depreciates in value compared to the other).
Passive participation: Anyone can provide liquidity and earn fees passively, without needing to actively trade or set prices.
Example: Uniswap, SushiSwap.
WHAT IS A CLOB (Central Limit Order Book)?
Centralised or decentralised model: CLOBs are used in traditional centralised exchanges (CEXs) as well as some decentralised exchanges.
Order Book: CLOBs maintain a live ledger of buy and sell orders with specific prices and quantities. Traders place limit or market orders, and the system matches buyers with sellers based on price and time priority.
Pricing: Prices are determined by the highest bid (buy order) and the lowest ask (sell order). Market participants directly interact with each other by placing and accepting orders.
Liquidity providers (market makers): Market makers in a CLOB actively set bid and ask prices to provide liquidity. They manually or algorithmically update their prices to match market conditions.
More sophisticated trading: CLOBs typically allow for a wider range of order types, such as stop-loss orders, limit orders, and advanced strategies.
Example: New York Stock Exchange (NYSE), Binance, FTX (when it was operational).
WHAT IS CARBON DEFI?
Bancor’s Carbon DeFi is positioned as an evolution of the Automated Market Maker (AMM) model, improving upon both traditional AMMs and Central Limit Order Books (CLOBs) by addressing some of the core limitations inherent in both models. Here’s a breakdown of why Carbon is considered a significant step forward and why it can be seen as better than both AMMs and CLOBs:
1. Evolution Beyond AMMs:
A. Customisable Liquidity Provision (Range Orders):
Traditional AMMs: In platforms like Uniswap V2 or Bancor V2, liquidity providers (LPs) deposit assets into a pool, and the AMM’s algorithm automatically prices trades based on the asset ratio. This simplicity comes at a cost: impermanent loss (where LPs lose potential profit as prices shift away from their original deposit value) and non-targeted liquidity provision (liquidity is provided across the entire price curve, regardless of market demand).
Carbon’s Solution: Carbon introduces range orders that allow liquidity providers to define specific price ranges within which they want to provide liquidity. This customisation means:
LPs can focus their liquidity where it’s most needed or where they believe they can earn the most fees.
No impermanent loss because liquidity is only exposed within defined price ranges.
This feature resembles the benefits of limit orders from CLOBs but in a non-custodial, decentralised manner.
B. Asymmetric Liquidity Provision:
In Carbon, liquidity providers can deposit a single asset and choose one-sided liquidity. Unlike traditional AMMs where liquidity needs to be provided as pairs of assets, Carbon allows for more flexibility in terms of which assets users deposit and in which direction they expect the price to move.
2. Superior to CLOBs:
A. Non-custodial, Permissionless, and Decentralised:
CLOBs on centralised exchanges (CEXs) like Binance or the NYSE offer highly efficient order execution but come with the drawbacks of custody risks, centralised control, and potential downtime or manipulation.
Carbon operates as a non-custodial platform where users retain full control over their assets, even while providing liquidity or creating range orders. It is permissionless and decentralised, ensuring transparency and reducing risks associated with intermediaries.
B. No Reliance on Constant Market-Making:
In a CLOB system, market makers need to actively place orders and adjust them based on the market’s bid-ask spread. This requires sophisticated algorithms or manual management.
In Carbon, liquidity provision is passive yet targeted. Liquidity providers simply define their ranges and let the protocol work autonomously without the need for constant adjustments or external algorithms to manage spreads. This results in a more accessible and less management-intensive experience for liquidity providers.
3. Combining the Best of AMM and CLOBs:
A. Efficient Pricing and Targeted Liquidity:
Traditional AMMs use simple algorithms (e.g., constant product formula) that are easy to implement but lead to price inefficiencies and high slippage for large trades.
CLOBs provide better pricing but rely on active trading participants and market makers to maintain liquidity.
Carbon combines the best of both worlds by offering targeted, algorithmic liquidity that reduces slippage (because liquidity is provided more precisely within set price ranges) and improves trade execution. Unlike CLOBs, this doesn’t require active market participants constantly adjusting their orders, as the system manages liquidity automatically based on pre-defined conditions.
B. No Impermanent Loss & Optimised Yield:
Impermanent loss has been a significant issue for AMMs, where liquidity providers suffer losses if asset prices move in unexpected directions.
In Carbon, impermanent loss is avoided by allowing LPs to provide liquidity only in price ranges they choose, turning them into effectively dynamic limit orders with the potential for optimised yield without exposing themselves to unnecessary risk.
4. Predictive and Automated Rebalancing:
One of the advanced features in Carbon is its ability to automate rebalancing when certain price conditions are met. Liquidity providers can set up systems where their liquidity shifts dynamically, based on how the market moves. This feature resembles algorithmic trading strategies in CLOBs but in a fully decentralised, automated environment.
5. Capital Efficiency:
Traditional AMMs like Uniswap V2 suffer from capital inefficiency as liquidity is spread across the entire price curve. Uniswap V3 made improvements with concentrated liquidity, but it still relies on a wide range of participation from LPs.
Carbon’s approach of letting LPs define narrow, specific price ranges means that liquidity is much more concentrated and efficient. Liquidity providers can maximise their returns by only deploying capital where it is most likely to be utilised, improving overall market efficiency and returns.
6. Better for Traders & Liquidity Providers:
For traders: Carbon offers more efficient trade execution with less slippage than traditional AMMs, and the ability to interact with predictable, narrow liquidity bands makes trades less costly in terms of price impact.
For liquidity providers: Carbon offers a more customisable experience where they can provide liquidity in a targeted way, earning better fees without the risk of impermanent loss or the need for active management.
Conclusion: Why Carbon is Better Than AMM and CLOB
Carbon combines the best features of AMMs and CLOBs into a single, decentralised solution that offers greater capital efficiency, no impermanent loss, customisable liquidity provision, and advanced automation features like range orders and automated rebalancing.
It enables passive, non-custodial liquidity provision while offering traders the benefits of efficient price execution with low slippage—making it a powerful next step in the evolution of decentralised trading platforms.