Automated Market Makers (AMMs) are a cornerstone of DeFi. With a few clicks, anyone can provide liquidity for a token, creating a permissionless market in a way that was never possible before. It's a simple innovation that unlocked liquidity for millions of assets, fueling the explosive growth of onchain markets.

For builders, they seem like a great solution for bootstrapping liquidity. Yet they have critical flaws that impact tokens at every stage of their lifecycle. In this article, we will briefly go over some of the issues surrounding the use of AMMs for projects, the most common alternative, and what we believe is missing.

X*Y=K, a Blessing and a Curse

The first and most recognized model is the Constant Product Market Maker (CPAMM), famously represented by the formula x*y=k and first implemented by Uniswap in 2018, and gaining widespread traction around 2020.

This design's beauty is its simplicity and elegance; it is easy to understand, and it just works. However, this same simplicity is the source of significant, persistent problems.

For all their benefits, CPAMMs create a challenging environment for both liquidity providers (LPs) and traders.

For LPs, the primary issues are Impermanent Loss (IL) and Loss-Versus-Rebalancing (LVR). Impermanent Loss is the opportunity cost LPs suffer when the price of the assets in a pool diverges—they often would have been better off just holding the tokens. LVR is a more insidious problem; it's the systematic profit extracted from LPs by arbitrageurs who are always faster and better informed, effectively bleeding value from the pool.

For traders, the main threat is MEV (Maximal Extractable Value), most commonly seen in the form of "sandwich attacks." A trader's swap is targeted by a bot that places a large order right before it and an opposite order right after, artificially inflating the price the trader pays and pocketing the difference.

Most importantly, CPAMMs are highly dependent on the amount of liquidity in their pools. Pools with low liquidity are notoriously easy for whales to manipulate, causing wild price swings. The common solution is to provide high-yield liquidity rewards for LPs, but this often is an additional cost and complexity for projects. It attracts mercenary capital that provides liquidity only for the rewards and vanishes the moment they dry up, leaving projects in a worse position.

Concentrated Liquidity

In 2021, Uniswap V3 introduced the Concentrated Liquidity AMM (CLAMM). This model allows LPs to provide liquidity within specific price ranges, promising greater capital efficiency and better control over the risk LPs take.

For high-volume pairs like ETH/USDC, CLAMMs have been a major step forward. However, they are not a silver bullet. They still suffer from LVR and MEV issues, and their increased flexibility also comes with its own challenges. Managing a CLAMM position is significantly more complex, requiring active monitoring and adjustments.

This complexity makes CLAMMs impractical for the long tail of smaller, less liquid tokens. For these assets, liquidity becomes fragmented and difficult to manage. It's no surprise that even four years after their introduction, the total value locked (TVL) in simple CPAMMs still rivals, and in many cases exceeds, that of their more complex successors.

The Retreat Off-Chain

Frustrated with the trade-offs of onchain AMMs, many projects have turned to the traditional solution of utilizing private market makers. These solutions offer better pricing for traders but come at a steep cost, often requiring huge incentives for the MMs. This comes in the form of token loans and extremely disadvantageous option structures.

It's not that these MMs are all evil or extractive. The process of providing liquidity for new tokens is extremely risky, and MMs are profit-seeking businesses who must ensure they can make their profits. In addition, there have been many cases of market makers wrecking token performance and being caught in clearly manipulative practices. The truth is, professional MMs require a high amount of trust to act in good faith.

This leaves project founders in a difficult position. To bootstrap liquidity, a critical step for any new token, they must make a huge tradeoff:

Risk manipulation and unsustainable incentives on a simple AMM.
Struggle with the complexity and ineffectiveness of a CLAMM.
Navigate the world of professional market makers before they're ready, forcing them to create potentially disadvantageous deals to secure their liquidity.

What's Missing?

A clear gap exists in the market. The current landscape serves high-volume, blue-chip assets well, but it fails the very innovators and builders that push the crypto space forward. These projects need a way to build sustainable, efficient liquidity without becoming market makers themselves or sacrificing the benefits of decentralization.

In a space defined by innovation and experimentation, the next evolution of AMMs must be designed for this underserved segment. The liquidity problem for new and growing projects is waiting for a real solution.

Baseline is designed from first principles around the problems outlined above. We are crypto natives, believing that onchain, programmable liquidity via AMMs can solve these issues. The first step is identifying the problem.

Stay tuned for more.