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TITLE: Exploring Bonding Curves: Outlining Primary and Secondary Automated Market Makers SUBTITLE: Key DeFi Primitives Enable Economic Bootstrapping and Exchange
*This piece aims to provide an exploration and comparison of two classes of bonding curves (also called Automated Market Makers or AMMs) that serve important functions in token ecosystems. This article will explain the basics of PAMMs and SAMMs as part of a larger effort to further define the bonding curve design space, with subsequent articles diving deeper into configurations of these tools for more sustainable token economies.
The Bonding Curve Research Group, in collaboration with the Token Engineering Commons, aims to further the research, development, and education around the topic of bonding curves, particularly in their use as dynamic issuance mechanisms for cryptographic tokens.*
The first are Primary AMMs or PAMMs, which facilitate the issuance and redemption (i.e. minting and burning) of tokens in exchange for deposited assets (most often stablecoins). The second are Secondary AMMs or SAMMs, which facilitate the exchange of tokens already in existence. Both of these tools use an algorithmic invariant, called a bonding curve, to determine the appropriate pricing of their tokenized assets relative to each other. While SAMMs are fairly prevalent and diversified in the DeFi space already (e.g. in Bancor, Balancer, Uniswap, Curve, and many more), PAMMs are relatively obscure and thus far have received far less attention, despite the promising benefits they offer tokenized ecosystems as tools for dynamic token issuance.
Bonding curves are an extremely useful (and often poorly understood) mathematical concept that describe the relation between two or more assets. At this point, certain types of bonding curves are fairly ubiquitous in web3, but they are often embedded so deeply in tools like Automated Market Makers (AMMs) that they can be hard to spot, unless you know what to look for.
Bonding curves can also be applied in many novel ways that have not even been tried yet, and could hold the potential to address several prominent challenges of launching and maintaining sustainable token ecosystems.
As mechanisms for funding projects and distributing tokens, they enable communities to participate in wealth creation and invest in projects that align with their shared values.
A bonding curve, in its most basic form, is an algorithm managing the proportion of a pair (or basket) of assets held in a smart contract ‘liquidity pool’. As trade between those assets changes the proportion of assets in the pool, the algorithm adjusts its bid/offer prices to reflect the rebalance of assets. The bonding curve dynamically adjusts the prices that will be offered for the assets based on supply & demand, according to an algorithmically determined ratio.
<Diagram demonstrating the exchange ratios at different points forming a ‘curve’>
between two different assets, which has enabled mass trading for the majority of cryptographic tokens since 2019. Prior to the rise of decentralized exchanges like Uniswap, which operate using various forms of bonding curves for tokenized asset pricing, centralized exchanges matched buyers and sellers using more traditional ‘order book’ markets. The difficulty with these markets was that there was not much order depth for the vast majority of tokens, outside of a few popular tokens like Bitcoin and Ethereum.
While SAMMs have provided essential benefits to token ecosystems through exchange liquidity for the past 4 years, other forms of bonding curves may yet offer similar leverage in the future.