Markets on Bitsy Wiki

Decentralized Exchange

Mon, 01 Jan 0001 00:00:00 +0000

A decentralized exchange (DEX) is a marketplace for trading tokens that runs on-chain, without a central operator holding custody of user funds. Trades settle directly between the user’s wallet and a smart contract.

A centralized exchange (CEX) like Coinbase or Binance takes deposits into its own custody, matches orders on an order book it operates, and pays out on request. A DEX replaces all three with smart contracts, and the tokens stay in the trader’s wallet until the block that executes the swap. There is no account to create, no KYC gate, and no withdrawal queue, because there is nothing on deposit to withdraw.

Automated Market Maker

Mon, 01 Jan 0001 00:00:00 +0000

An automated market maker (AMM) is a type of decentralized exchange that uses a mathematical formula – rather than an order book – to price trades. Traders swap against a liquidity pool instead of matching with a counterparty.

Traditional exchanges work by matching buyers and sellers: someone posts a bid, someone posts an ask, and the exchange matches them. This requires active market makers who continuously quote prices and enough participants on both sides to maintain a liquid book. On a blockchain, where every operation costs gas and blocks are seconds apart, maintaining an on-chain order book is expensive and slow. AMMs side-step the problem entirely. A smart contract holds reserves of two tokens, and a pricing function determines the exchange rate based on the ratio of those reserves. Anyone can trade at any time, and anyone can supply liquidity.

Liquidity Pool

Mon, 01 Jan 0001 00:00:00 +0000

A liquidity pool is a smart contract that holds reserves of two or more tokens and allows anyone to trade against those reserves according to a deterministic pricing function. Pools are the core primitive of AMM-based decentralized exchanges.

On a traditional exchange, liquidity comes from market makers who post bids and asks on an order book. On-chain, that model is impractical – gas costs and block times make continuous order management expensive. Liquidity pools solve this by letting anyone deposit tokens into a contract that automatically quotes prices using a formula like the constant product. Traders swap against the pool’s reserves; liquidity providers (LPs) earn a share of the fees.

Constant Product Formula

Mon, 01 Jan 0001 00:00:00 +0000

The constant product formula is the pricing rule at the heart of most AMM-based decentralized exchanges. A liquidity pool holds reserves of two tokens, and their product must remain constant through every trade.

`1`	`x * y = k`

where x and y are the reserve quantities and k is the invariant. Uniswap V2, SushiSwap, and most early AMMs use this formula. Slippage and impermanent loss are both consequences of this single constraint rather than separate mechanisms.

Constant Mean Formula

Mon, 01 Jan 0001 00:00:00 +0000

The constant mean formula is the pricing invariant behind Balancer’s weighted pools. Where the constant product formula constrains two-asset pools to a 50/50 split, the constant mean formula generalises to any number of assets with arbitrary weight ratios – 80/20, 60/20/20, or any combination that sums to 100%.

This makes it possible to build liquidity pools that behave like self-rebalancing index funds: LPs choose the asset mix they want exposure to, and the AMM maintains those proportions through trading fees rather than manual rebalancing.

Virtual Reserves

Mon, 01 Jan 0001 00:00:00 +0000

Virtual reserves are a mathematical abstraction used by AMMs to make a limited amount of real capital behave like a much larger liquidity pool. The idea is central to Uniswap V3’s concentrated liquidity and appears in various forms across other protocols.

The problem virtual reserves solve#

In a standard constant product pool, liquidity is spread across every price from zero to infinity. If a pool holds 10 ETH and 25,000 USDC, most of that capital sits at prices far from the current market and never facilitates a trade. The capital is real but idle.

Impermanent Loss

Mon, 01 Jan 0001 00:00:00 +0000

Impermanent loss (IL) is the difference in value between holding tokens in a liquidity pool and simply holding them in a wallet. It is the cost a liquidity provider (LP) pays for the pool’s automatic rebalancing, and on a volatile pair it can exceed everything the position earns in fees over the same period.

Intuition#

An automated market maker (AMM) pool always sells the token that is going up and buys the token that is going down. This is the mechanism that keeps the pool’s price in line with the market. The side effect is that an LP ends up with less of the appreciating token and more of the depreciating one — the opposite of what a holder would have.

Volatility

Mon, 01 Jan 0001 00:00:00 +0000

Volatility measures how much an asset’s price moves over a given period. In traditional finance it is a statistical concept – the annualised standard deviation of returns. In DeFi it is an input rather than a description: it sets impermanent loss, the loan-to-value ratio a lending protocol will accept, the premium on an option, and whether a liquidity pool position clears its costs.

Cryptocurrency markets are structurally more volatile than most traditional asset classes. Tokens trade 24/7 on fragmented venues with thin order books, and prices respond sharply to regulatory news, exploit events, and social-media momentum.

Maximal Extractable Value (MEV)

Mon, 01 Jan 0001 00:00:00 +0000

Maximal Extractable Value (MEV) is the profit that can be captured by reordering, inserting, or censoring transactions within a block. It exists because the order in which transactions execute affects their outcomes — and the entity assembling a block gets to choose that order.

It is charged against every DEX trade, every lending-protocol liquidation, and every on-chain auction, and it surfaces downstream as reverted transactions, gas spikes, and protocol designs built specifically to deny it.

Staking

Mon, 01 Jan 0001 00:00:00 +0000

Staking is the act of locking cryptocurrency in a protocol to earn rewards. The term covers two distinct mechanisms: network staking, where locked tokens secure a blockchain’s consensus, and DeFi staking, where tokens are deposited into smart contracts to earn yield from protocol activity.

Both forms make the same trade: capital is committed and illiquid for a defined period, and the payment is for the service the locked capital performs while it sits there.

Yield Farming

Mon, 01 Jan 0001 00:00:00 +0000

Yield farming is the practice of deploying crypto assets across DeFi protocols to earn returns – trading fees, interest, or token rewards. It is also called liquidity mining when the rewards come in the form of a protocol’s governance token.

The basic idea: protocols need liquidity to function. Decentralized exchanges need tokens in liquidity pools. Lending platforms need depositors. Rather than wait for capital to arrive organically, protocols offer incentives – often their own token – to attract it. Yield farmers chase those incentives, moving capital to wherever the returns are highest.

Transfer on Join/Exit vs. Mint/Burn

Mon, 01 Jan 0001 00:00:00 +0000

When a user deposits assets into a liquidity pool or vault, the protocol needs a way to track their share. Two design patterns dominate: transfer on join/exit, which moves pre-existing tokens to represent membership, and mint/burn, which creates and destroys share tokens on the fly. The choice between them shapes a protocol’s accounting model, composability, and gas profile.

Transfer on Join/Exit#

In this pattern, the pool contract accepts a deposit and records the user’s share in internal storage – a mapping from address to balance. No new tokens are created. When the user withdraws, the contract updates the ledger and transfers the underlying assets back.

Prediction Market

Mon, 01 Jan 0001 00:00:00 +0000

A prediction market is a platform where participants trade contracts whose payout depends on the outcome of a future event. The market price of each contract reflects the crowd’s estimated probability of that outcome. If a “Yes” share on “Will ETH be above $5,000 on December 31?” trades at $0.35, the market is pricing a 35% probability.

In DeFi, prediction markets run on smart contracts that handle market creation, trading, and settlement without intermediaries. The blockchain provides the settlement guarantee: once the outcome is determined, the contract pays winners automatically and irreversibly.

Prediction Market Event Time

Mon, 01 Jan 0001 00:00:00 +0000

Event time is the moment a prediction market determines its outcome. It governs when trading stops, when resolution begins, and when winning shares become redeemable. It sits at the intersection of real-world timing, oracle reliability, and smart contract mechanics, and getting it wrong strands capital in a decided market, settles an undecided one, or resolves the wrong side of a close call.

Resolution Lifecycle#

A typical on-chain prediction market moves through several time-bound phases: