Liquidity Provision and Automated Market Making

Ciamac Moallemi

An introduction to constant function market makers (CFMMs), which have emerged as the dominant mechanism for decentralized exchange on blockchains. Ciamac Moallemi (Columbia University) resolves the apparent difference between CFMMs and the dominant mechanism in traditional finance, electronic limit order books. He defines a unifying framework for liquidity provision, and illustrates how CFMMs and limit order books are both mechanisms within this framework. Ciamac then considers the economics of CFMMs from the perspective of liquidity providers (LPs), decomposing the return of an LP into a market risk component and a predictable, increasing adverse selection component called “loss-versus-rebalancing” (LVR). LVR is a new running cost that must be offset by trading fee income for liquidity provision to be profitable, providing a useful benchmark to assess CFMM LP investment decisions. It can also inform the design of CFMM protocols.


The views expressed here are those of the individual AH Capital Management, L.L.C. (“a16z”) personnel quoted and are not the views of a16z or its affiliates. Certain information contained in here has been obtained from third-party sources, including from portfolio companies of funds managed by a16z. While taken from sources believed to be reliable, a16z has not independently verified such information and makes no representations about the current or enduring accuracy of the information or its appropriateness for a given situation. In addition, this content may include third-party advertisements; a16z has not reviewed such advertisements and does not endorse any advertising content contained therein.

This content is provided for informational purposes only, and should not be relied upon as legal, business, investment, or tax advice. You should consult your own advisers as to those matters. References to any securities or digital assets are for illustrative purposes only, and do not constitute an investment recommendation or offer to provide investment advisory services. Furthermore, this content is not directed at nor intended for use by any investors or prospective investors, and may not under any circumstances be relied upon when making a decision to invest in any fund managed by a16z. (An offering to invest in an a16z fund will be made only by the private placement memorandum, subscription agreement, and other relevant documentation of any such fund and should be read in their entirety.) Any investments or portfolio companies mentioned, referred to, or described are not representative of all investments in vehicles managed by a16z, and there can be no assurance that the investments will be profitable or that other investments made in the future will have similar characteristics or results. A list of investments made by funds managed by Andreessen Horowitz (excluding investments for which the issuer has not provided permission for a16z to disclose publicly as well as unannounced investments in publicly traded digital assets) is available at

Charts and graphs provided within are for informational purposes solely and should not be relied upon when making any investment decision. Past performance is not indicative of future results. The content speaks only as of the date indicated. Any projections, estimates, forecasts, targets, prospects, and/or opinions expressed in these materials are subject to change without notice and may differ or be contrary to opinions expressed by others. Please see for additional important information.