The Hidden Architecture of Extraction in Constant Product AMMs

Impermanent loss is not a temporary accounting quirk; it's a structural fee paid by liquidity providers (LPs) to arbitrageurs. The constant product formula x*y=k ensures LPs systematically underperform a simple buy-and-hold strategy of the paired assets in any trending market.

• The fee is asymmetric: LPs bear 100% of the rebalancing cost, while fees only compensate if volume outpaces volatility.
• The result is predictable: In a 2x price move, an LP suffers ~5.7% IL vs. HODL, requiring significant fee income just to break even.

Uniswap V3's innovation was allowing LPs to define price ranges, concentrating capital where it's most effective. This turns the AMM from a passive, lossy vault into an active capital management tool.

• Capital efficiency jumps: LPs can achieve 100-4000x more capital efficiency vs. V2 for the same depth.
• The trade-off is complexity: LPs now face amplified impermanent loss within their chosen band and must actively manage positions, shifting risk from passive loss to active management error.

Every AMM pool is a live, on-chain price oracle. Arbitrageurs like MEV bots don't just correct prices; they extract the delta between the stale pool price and the global market price. This is the primary mechanism of value extraction from LPs.

• Extraction is guaranteed: The math of x*y=k defines the exact profit an arbitrageur can capture on every price-moving trade.
• The system's purpose: This 'loss' to LPs is the feature, not the bug—it's the cost of creating a permissionless, composable price discovery mechanism that protocols like Chainlink or MakerDAO can leverage.

While LPs and arbs battle, the protocol's fee switch is a critical variable. A 0.05% vs. 0.30% fee radically changes the LP's break-even volatility threshold and the arb's profit margin.

• The trilemma: Higher fees protect LPs but reduce swap volume and competitiveness vs. rivals like Curve or PancakeSwap.
• The real yield: For protocols, sustainable fee revenue depends not just on TVL, but on attracting the volume that survives this fee friction, a battle now fought by aggregators like 1inch and ParaSwap.

New architectures like UniswapX and CowSwap abstract the AMM pool itself. Users submit intent ("I want X for Y") and a network of solvers (including AMMs, private market makers, OTC desks) compete to fulfill it.

• The AMM becomes a fallback: Constant product pools are just one potential liquidity source in a solver's bundle, often used to fill residual amounts.
• Extraction shifts: Value capture moves from on-chain arb bots to off-chain solver competition and efficient routing across venues like Balancer, Curve, and layerzero omnichain pools.

Providing liquidity in a CP-AMM is not a passive investment; it's selling a portfolio of short gamma (volatility) options to the market. The "yield" is the premium collected from swap fees.

• The fundamental trade: LPs are volatility sellers, arbs are volatility buyers. The AMM is the automated exchange for this derivative.
• The future: Advanced AMMs (e.g., Maverick, Ambient) are explicitly building this logic in, allowing LPs to express direct views on volatility and price ranges, finally aligning the product with its inherent financial reality.