🐮CoW Protocol

TL;DR: CowSwap, Loss vs Rebalancing & Function Maximizing AMM's Case Study

• CoW Protocol is a meta-DEX aggregation protocol using trade intents and batch auctions to secure better trading prices for users. It operates through third-party "solvers" who identify optimal execution paths across various liquidity sources, including AMMs, DEX aggregators, and private market makers.

• Loss Versus Rebalancing (LVR): LVR refers to the difference in performance between a liquidity provider’s (LP) portfolio and a rebalanced portfolio, which is rebalanced according to prices on centralized exchanges (CEXs). Due to unequal information, informed traders exploit price volatility in AMMs, draining an estimated $1 billion from liquidity providers in 2023 through a phenomenon called Loss-Versus-Rebalancing (LVR).

• FM-AMM (Function-Maximizing Automated Market Maker): FM-AMM aims to address AMM inefficiencies by batching trades to eliminate arbitrage and sandwich attacks. It uses a function-maximizing approach to adapt to market conditions and optimize liquidity reserves.

• CowSwap Auction Mechanics: CowSwap uses batch auctions for trading, where solvers compete to provide the best trade execution, leveraging both external and internal liquidity sources to ensure optimal prices and MEV protection and mitigate LVR

• Benefits for Traders and LPs: Traders benefit from better prices and reduced slippage, while LPs enjoy the elimination of impermanent loss and earn surplus akin to fees from internal trades within the batch

Overview

CoW Protocol is a meta-DEX aggregation protocol that leverages trade intents and batch auctions to find users better prices for trading crypto assets.

The protocol relies on third parties known as "solvers" to find the best execution paths for trade intent— signed messages that specify conditions for executing transaction on Ethereum and EVM-compatible chains.

Liquidity sources include:

• AMMs (e.g. Uniswap, Sushiswap, Balancer, Curve, etc.)

• DEX Aggregators (e.g. 1inch, Paraswap, Matcha, etc.)

• Private Market Makers

The wide range of liquidity that solvers tap into makes CoW Protocol a meta-DEX aggregator, or an aggregator of aggregators.

How does it work?

CowSwap has introduced a revolutionary approach to trading: A delegated trading model through an Order Flow Auction that runs on batch auctions to find the best settlement for all the trades. In batch auctions, traders submit their intent to trade a token pair without settling their trades directly on-chain. Solvers handle transaction creation, allowing traders to avoid fine-tuning parameters like liquidity pools and slippage. This approach provides better prices and MEV protection.

Auction Mechanics

In the CowSwap auction, solvers compete to propose optimal solutions for executing the batch trades. These solutions may involve leveraging external liquidity sources such as existing automated market makers (AMMs) or collaborating with private market makers to access otherwise unavailable liquidity. Additionally, solvers may explore internal liquidity within the batch, facilitating direct trades between participants seeking complementary assets.

Price Improvement

Price improvement refers to securing the best possible price for a trade. CoW Swap revolutionizes decentralized trading by using surplus, ensuring traders get optimal prices. When a trader submits a signed order, it goes to an off-chain orderbook and into a batch auction. Solvers then search all available on-chain liquidity to determine the best clearing price.

CoW Swap improves pricing by batching orders and establishing a uniform clearing price, creating a more liquid environment. Coincidences of Wants (CoWs) enable direct peer-to-peer transactions, bypassing intermediary AMM pools, reducing slippage, and avoiding additional fees.

In the trading UI, CoW Swap quotes the minimum price a trader will receive, often providing price surplus by delivering more of the desired tokens. This method enhances trading efficiency and benefits traders with better prices

To learn more about the concepts CoW Protocol makes use of, see Concepts.

For more info on how to use CoW Protocol or CoW Swap, see Tutorials.

To dive into the technical details, see Technical reference.