How does O2DEX innovatively solve the liquidity predicament of DEX?

This article intends to explain how O2DEX reduces the investment risk of liquidity providers in DEX through the design of the O2DEX AMM mechanism and economic model, and how it benefits every user in the ecosystem through the deflation mechanism, mainly involving the market maker models, incentives, and deflation mechanisms.

Being an important role in exchanges, market makers provide sufficient liquidity for transactions, allowing people to quickly buy or sell assets in the market. AMM replaces the manual quotations of traditional market makers with algorithms. The market makers in DEX are called liquidity providers. They add a large number of tokens to the token pool which accumulates the liquidity of market makers, enabling other users to have the same trading experience as on a traditional exchange.

In the traditional AMM, taking the most classic constant product model (CPMM) as an example, Uniswap is a typical instance. CPMM is based on the function X*Y=K, which determines the price range of two types of tokens according to the available quantity (liquidity) of each token. When the supply of token X increases, the supply of tokens for Y decreases, and vice versa, eventually maintaining the constant product K.

The AMM mechanism allows anyone to be a market maker to obtain commission charges income as a liquidity provider. But this is not a risk-free investment, because impermanent losses exist in AMM. When the market experiences severe fluctuations, the liquidity provider assets may be exposed to asset loss.

For example, when the token price falls rapidly, the token price will deviate during the transaction process. At this time, the liquidity provider needs to bear additional losses besides the price fall. If this part of the loss cannot be compensated by the commission charge reward, liquidity providers will be discouraged, resulting in insufficient liquidity in the trading pool, reducing users’ willingness to trade. Consequently commission charge rewards decrease, triggering a vicious circle.

O2DEX’s Solution

O2DEX improves the traditional AMM mechanism and adopts a variable K value model, which aims to provide liquidity providers with more value empowerment, reducing their exposure to asset price fluctuations, thus encouraging more users to contribute to the liquidity in O2DEX. Sufficient liquidity improves the trading experience and drives up commission charges, which further fosters the enthusiasm of liquidity providers.

Let’s take a look at the advantages of the O2DEX variable K value trading model with the following example.

Alice is a liquidity provider in the ToKen A/USDT trading pool. The current price of ToKen A is 100 USDT, and she has deposited 100 A and 10,000 USDT into the pool. According to the CPMM model, the constant K is 1,000,000 now. If someone sells 50 A in the trading pool, the number of A will be 150 and the number of USDT will be 6666.67. The price of A will drop to 44.44 USDT.

The total value of Alice’s assets at this time is 44.44*150+6666.67=13332.67 USDT, plus the commission charges (ignored for the convenience of calculation).

If the improved market maker mechanism of O2DEX is adopted, in this transaction, 50 A will not directly enter the transaction pool. In fact, 50% will be allocated to the black hole address and 50% goes to Alice, totaling 100 A in the transaction pool, including 6666.67 USDT. The K value becomes 666667 and the price of A is 66.67 USDT. The total value of Alice’s assets is 66.67*125+6666.67=15000.42 USDT, 1667.75 USDT higher than the asset value calculated under the traditional AMM mechanism. This part of value increase is the empowerment that O2DEX brings to liquidity providers.

The example above shows when token price falls, the assets in O2DEX demonstrate more resistance to value decline, which means that when some assets with small market value and significant price fluctuations are traded, O2DEX’s trading mechanism can fully protect the rights and interests of traders and liquidity providers. Traders trade assets at better prices, and liquidity providers do not have to bear the risk of excessive price fluctuations.

Extreme deflationary economic model

In O2DEX, when the assets are traded, the sold tokens will not directly enter the trading pool. In fact, 50% will directly enter into the black hole address for destruction, and the 50% left will be rewarded to the liquidity providers proportionally. As the trading volume of tokens rises, the total amount of tokens will continue to decrease, driving up the scarcity of tokens. The value of tokens will continue to rise while the market value remains unchanged.

This mechanism applies to all tokens traded in O2DEX, including O2DEX’s platform token O2 itself.

The total number of O2 tokens issued is constant at 1 billion, and it has been under a deflation model since the issuance. O2DEX has designed a double deflation mechanism for O2 tokens. In addition to the destruction during the transaction process mentioned above, another approach of Repurchase and Destruction is also applied.

A commission charge of 0.3% will be charged on each transaction in O2DEX, including 0.25% rewarded to the liquidity providers in the corresponding trading pool, and the remaining 0.05% used to purchase the platform token O2 which directly goes to the black hole address for destruction. The process above is automatically executed by the smart contract, which is publicly available on the chain.

Repurchase and Destruction realize the deflation of tokens and is an important approach to enhance the value of the platform token O2. Repurchase is carried out using the commission charge income of O2DEX, which is equivalent to transferring profits to O2 holders, in order to encourage community users to participate in ecological construction more actively. It is in line with the concept of complete decentralization of the O2DEX project.

Conclusion

The innovative variable K-value AMM model and the deflation mechanism are the two engines that drive O2DEX forward. The AMM model reduces the investment risk of liquidity providers and motivates them to actively provide sufficient liquidity for O2DEX. The deflation mechanism rewards traders with value empowerment brought by token deflation, increasing their willingness to trade, and bringing in more commission charge income to liquidity providers. The two mechanisms complement each other and address the most important liquidity predicament in the current DEX.