Virtual Automated Market Makers (vAMMs)

Market makers are entities offering liquidity in exchange for a tradable asset which may be otherwise illiquid. They do this by selling and purchasing assets from their accounts to make a profit, often from the spread (the gap between the lowest sell offer and highest buy offer). Their trading activity generates liquidity, thereby reducing larger trades’ price impact.

With the basics of market makers clear, let’s learn about virtual automated market makers (vAMMs).

Understanding Virtual Automated Market Makers (vAMMs)

Before going into virtual automated market makers (vAMMs), it is essential first to understand what automated market makers (AMMs) are.

An AMM refers to a system which offers an automated smart contract platform in which traders can use liquidity from the liquidity providers to perform token swaps. An example of a highly popular AMM is the decentralized exchange (DEX), Uniswap. It uses a constant function of x*y=k to carry out token swaps.

Virtual Automated Market Makers (vAMM) is a new kind of AMM that builds on this foundation and expands its application from token swaps to perpetual contracts. 

It works similar to a non-virtual AMM having a constant product curve (x*y=k) with an exception – the liquidity is virtual, as the name suggests. This implies that there is no exchange of assets. Also, the vAMM does not hold an asset pair’s two sides in custody. 

Notably, Perpetual Protocol first introduced the virtual automated market maker (vAMM) concept.

Properties of a vAMM

• Non-requirement of liquidity providers

To bring liquidity for a vAMM to work, there is no requirement for the existence of liquidity providers. The traders offer liquidity to every order. Also, as there is no need for a liquidity provider in a vAMM, no impermanent loss exists.

• Managing slippage

Similar to conventional AMMs, traders face less slippage for vAMMs when the value of K is greater. However, this similarity ends there. 

In contrast to AMMs, as the vAMM operator manually sets the value of K at launch, it is possible to voluntarily increase or decrease it at any time, even after the creation of vAMM. This helps the market respond to the most current conditions. 

However, even though the vAMM operator boasts such power, it is impossible to move the funds saved inside the vault.

A vAMM is not used for spot trading but for price discovery in handling leverage. The vAMM calculates the exit or entry price each time one makes a trade. This calculation takes place the same way as price calculation occurs on AMM-style exchanges. The first-generation vAMMs made use of a fixed formula to calculate prices. But the second-generation vAMMs use a robust liquidity design and virtual tokens to enable makers to offer liquidity with leverage.