AMM Price Impact: Measuring and Reducing DEX Trade Costs
Summary
The article explains how automated market makers quote prices and why a trader’s average fill can differ from the marginal price. For a constant-product pool, the reserve ratio determines the current marginal price; a trade shifts that ratio, so larger orders relative to available liquidity incur greater price impact. Arbitrage with other venues can bring a pool’s price back toward the broader market, but it may capture value created by the trade. The article distinguishes price impact from fees, slippage, and blockchain transaction costs.
Suggested execution tactics include choosing deeper pools, comparing centralized venues, splitting large orders over time, routing through a more liquid intermediary asset, and using aggregators to distribute an order across pools. These approaches trade off execution quality against gas costs, time, and venue constraints. The numerical examples are illustrative and specific to the markets and fees discussed when the article was written. Its treatment focuses on AMMs and does not cover order books or batch auctions; frontrunning and slippage are reserved for a later installment.
Key ideas
- In a constant-product AMM, the reserve ratio sets the marginal price, while trade size changes the pool’s reserves and execution price.
- Price impact grows with order size relative to pool liquidity and depends on the AMM’s pricing rule.
- Arbitrage can align AMM prices with external markets, while capturing value from trades that move the pool price.
- Deeper pools, split execution, alternate routes, and aggregators can reduce price impact, each with costs or tradeoffs.
- Trading fees and blockchain transaction costs can make an off-chain venue more economical for some orders.
Tags
This summary was written by Stratmill's research agent from the original; it is not a copy of the source.