5 Market-Making Models in DEX Development You Should Know

Decentralized exchange development has reshaped crypto trading by eliminating intermediaries, offering users direct access to on-chain markets. However, one of the biggest challenges in decentralized exchange development is liquidity—ensuring that traders can execute orders efficiently without excessive price slippage. Unlike centralized exchanges, which rely on professional market makers, DEXs must use automated mechanisms to facilitate trading.

For DEX founders, choosing the right market-making model directly impacts capital efficiency, trading volume, and user experience. The wrong choice can lead to low liquidity, high slippage, and poor trade execution, making the platform uncompetitive. On the other hand, the right model can attract liquidity providers, optimize capital usage, and offer traders better pricing, helping a DEX stand out in a crowded market.

This is where market-making models come in. From the Constant Product Market Maker (CPMM) in Uniswap V2 to more advanced designs like Concentrated Liquidity Market Making (CLMM) in Uniswap V3 and Proactive Market Making (PMM) in DODO, liquidity provision has evolved to address capital inefficiency, trade execution, and slippage.

In this article, we’ll explore the key market-making models, their trade-offs, and how to choose the right one for a DEX based on its goals. Whether you're in the process of launching a DEX platform or optimizing an existing one, understanding these mechanisms is essential to making your exchange more efficient and competitive.

The Evolution of Market-Making in Decentralized Exchange Development

In decentralized exchange development, market-making models are a fundamental aspect of platform design. If you want your DEX to be competitive, you need a solid liquidity solution. Getting this right isn't just about avoiding slippage—it's about building a sustainable system that works at scale.

Early Challenges in Decentralized Exchange Liquidity Provision

When DEXs first came around, the idea was to replicate centralized exchange functionality, including the use of order books. But without centralized market makers, liquidity was thin, and matching orders in real time became a huge challenge in decentralized exchange development. This meant huge slippage, high costs for traders, and a less-than-optimal user experience.

AMMs - A Game-Changer for DEX Development

Then came AMMs. By letting liquidity providers pool assets in smart contracts, DEXs could now execute trades without relying on an order book. This was a huge win for decentralized exchange development, allowing for faster, easier trades. Uniswap introduced the Constant Product Market Maker (CPMM) model (x*y=k), but while it solved liquidity issues, capital efficiency became a new challenge — liquidity wasn’t allocated in the most effective way, which limited the performance of DEXs.

Capital Efficiency Becomes a Key Focus

As DeFi and DEXs continued to grow, more capital flooded into the market, leading to increased trading volume and a diverse set of participants—from traders to arbitrage bots. Liquidity providers now had more options and were increasingly selective about where to deploy their capital. The early AMMs couldn’t keep up with the demand for higher efficiency, and this led to innovations focused on improving capital efficiency.

Uniswap V3 marked a major step in the evolution of market-making by Concentrated Liquidity DEX Development. This innovation allowed liquidity providers to focus their capital in specific price ranges, optimizing its use and significantly reducing slippage. It helped tackle the inefficiencies of earlier AMM models, where liquidity was spread thinly across the entire price curve.

But the need for more advanced solutions didn’t stop there. As trading volumes grew, larger trades began to disrupt markets and cause slippage. This is where TWAMMs (Time-Weighted Automated Market Makers) came in. TWAMMs solved this by executing large trades over a period of time, ensuring that price fluctuations were minimized, and the market could absorb big orders more smoothly. This development represented another key step in the evolution of market-making, improving the way liquidity was handled and trades were executed.

The Next Step in DEX Development - Hybrid Models

As the DEX market scaled, founders began experimenting with hybrid models. These models take the best parts of different market-making strategies and combine them to address specific needs. For example, Proactive Market Makers (PMM), like the ones used by DODO, dynamically adjust liquidity around the mid-market price, ensuring that trades are executed efficiently even with shifting market conditions. Aggregation models, like 1inch, combine on-chain and off-chain liquidity, offering users better execution and lower slippage.

For DEX founders, these hybrid models offer flexibility—allowing you to tailor liquidity provision to your platform’s goals. Whether it’s a DEX focused on stable assets, high-frequency trades, or deeper liquidity, knowing how to implement and combine these models will give your platform a competitive edge.

Next, we’ll dig into the specific market-making models you can use for your DEX, exploring their strengths and weaknesses. Understanding these models is essential for making informed decisions as you develop your platform.

Overview of Market-Making Models in Decentralized Exchange Development

When it comes to decentralized exchange development, choosing the right market-making model is one of the most critical decisions you'll make. Every model brings something different to the table, whether it's balancing liquidity, cutting down slippage, or optimizing for capital efficiency. No one-size-fits-all solution here, and that’s what makes DEXs exciting to build.

In this section, we’ll break down the most important market-making models that are shaping decentralized exchanges today. Understanding each one is key for any founder who's serious about making their DEX competitive and scalable. Let’s dive in.

A. Traditional AMMs in Decentralized Exchange Development: CPMM, CFMM, CMMM

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When diving into decentralized exchange development, understanding the foundational market-making models is critical. Whether you're building your first DEX or optimizing an existing platform, knowing the strengths and weaknesses of different Automated Market Maker (AMM) models will help you create a more efficient, user-friendly exchange.

1. CPMM  - Constant Product Market Maker

How It Works

The Constant Product Market Maker (CPMM) follows the x * y = k formula, ensuring that liquidity is always available by adjusting token prices based on supply and demand. As more of one asset is bought, its price increases, creating a curve-based pricing mechanism.

✅ Pros of CPMM in Decentralized Exchange Development:

• Simple and widely adopted – The standard AMM model in DeFi, easy to implement and understand.
• Resilient and adaptable – Works well for volatile assets without external pricing oracles.

❌Cons of CPMM in Decentralized Exchange Development:

• High slippage on large trades – Because liquidity is spread across all price ranges, large trades suffer from significant price impact.
• Impermanent loss – LPs can experience losses compared to simply holding their assets, especially in volatile markets.
• Capital inefficiency – Liquidity remains underutilized as it is distributed across the full price range, even when most trades occur within a smaller range.

Example Protocols Using CPMM:

• Uniswap V2 – The first widely adopted DEX using CPMM, setting the standard for DeFi trading.
• PancakeSwap V2 – A popular BNB Chain-based DEX leveraging CPMM for yield farming and token swaps.

Despite its limitations, CPMM remains the backbone of many DEXs due to its simplicity and broad adoption.

Building a DEX inspired by existing models like Uniswap requires careful customization. Learn more in our related article - How to Create a DEX Like Uniswap

2. CFMM - Hybrid Constant Function Market Maker

How It Works

The Constant Function Market Maker (CFMM) improves upon CPMM by optimizing for stablecoin and low-volatility asset trading. It blends constant product and constant sum functions, concentrating liquidity in a way that minimizes slippage when assets remain closely correlated. This is especially useful for stablecoin and liquid stacking asset pairs like USDC/DAI or ETH/stETH.

✅ Pros of CFMM in Decentralized Exchange Development:

• High capital efficiency – More liquidity is available within the expected trading range, reducing price impact.
• Lower slippage for stable pairs – Trades experience minimal deviation from market prices, improving execution quality.
  
  

❌Cons of CFMM in Decentralized Exchange Development:

• Limited flexibility – Not suitable for volatile assets, as price movements outside the expected range lead to inefficiencies.
• Complex setup – Pool parameters must be fine-tuned to maximize efficiency, requiring deeper technical knowledge.

Example Protocols Using CFMM:

• Curve – The leading DEX for stablecoin trading, providing deep liquidity with minimal slippage.
• Maverick Protocol – Enhances CFMM by allowing active liquidity movement, adapting to market conditions.

For DEXs focused on stablecoin trading, pegged assets, or synthetic tokens, CFMM offers superior performance, though it lacks the flexibility of CPMM for volatile pairs.

3. CMMM - Continuous Market Maker Model

How It Works

Unlike CPMM, which uses a fixed 50/50 asset weighting, the Continuous Market Maker Model (CMMM) allows liquidity pools to contain multiple tokens with customizable weightings. This model is ideal for structured portfolios, index funds, and diversified liquidity pools. Liquidity providers can deposit assets in varying ratios (e.g., 80/20, 60/40, or even pools with more than two tokens), improving capital efficiency and flexibility.

✅ Pros of CMMM in Decentralized Exchange Development:

• Multi-asset pools – Supports liquidity pools with more than two tokens, enabling index-style fund structures.
• Custom weightings – LPs can allocate liquidity in different proportions, reducing impermanent loss risks.
• Efficient portfolio rebalancing – Pools naturally adjust asset distributions, functioning like automated index funds.

❌Cons of CMMM in Decentralized Exchange Development:

• More complex to manage – Multi-asset pools require active governance and technical expertise.
• Higher gas costs – Smart contract interactions are more resource-intensive, leading to increased transaction fees.
• Less intuitive for new users – Traders and LPs need to understand the implications of different weightings.

Example Protocols Using CMMM:

• Balancer – The most well-known protocol enabling multi-asset liquidity pools and automated portfolio management.

CMMM is a powerful model for DEXs offering structured investment products, automated portfolio balancing, or liquidity diversification, but its complexity requires careful implementation.

B. Advanced AMMs:  CLAMM, TWAMM, vAMM

1. CLMM  - Concentrated Liquidity Market Maker

Uniswap V3 introduced the Concentrated Liquidity Market Maker (CLMM), allowing liquidity providers to concentrate their capital within specific price ranges rather than across the entire curve.

Pros of CLMM in Decentralized Exchange Development:

• Higher Capital Efficiency: LPs can allocate liquidity only where trades are happening, making capital more productive.
• Lower Slippage: With more liquidity concentrated around the market price, traders get better execution.
• Custom Fee Tiers: LPs can choose different fee structures based on their risk tolerance and strategy.

Cons of CLMM in Decentralized Exchange Development:

• Active Management Required: LPs must frequently adjust their price ranges to stay competitive. This requires constant attention to market conditions and price fluctuations.
• Impermanent Loss Risk: If a token moves out of the LP’s chosen range, their liquidity becomes inactive. The LP will only hold the token that traders deposit into the pool, leaving the other token exposed to impermanent loss risk. For example, if a liquidity provider sets a range and the price of one token moves beyond this range, they may end up holding only one asset, significantly increasing their risk of impermanent loss.
• Solution – ALMs (Automated Liquidity Managers): ALMs have emerged to help LPs manage their liquidity ranges automatically, reducing the need for constant manual adjustments. These solutions track market conditions and adjust LP positions to keep liquidity within the most profitable range, mitigating the risk of becoming exposed to a single asset.

Example: Uniswap V3, KyberSwap Elastic, Algebra, and ALMs like Enzyme Finance and Yearn Finance’s automated strategies.

3. TWAMM  - Time-Weighted Automated Market Maker

TWAMM (Time-Weighted Automated Market Maker) is designed for large orders, splitting them into smaller trades over time to minimize price impact. This is especially useful for institutional trading or protocols executing long-term strategies.

Pros of TWAMM in Decentralized Exchange Development:

• Lower Price Impact: Large trades are broken into smaller portions to reduce market disruption.
• Better Execution for Institutions: Ideal for funds, DAOs, or protocols making gradual buy/sell decisions.
• Automated Trade Scheduling: Removes the need for manual execution of long-term trades.

Cons of TWAMM in Decentralized Exchange Development:

• Delayed Execution: Traders may experience a time lag before orders are fully executed.
• Limited Use Cases: Primarily benefits institutional players rather than retail traders.

Example: FRAXswap, Integral SIZE.

4. Virtual AMM – Perpetual Protocol

Perpetual Protocol’s Virtual AMM (vAMM) is an innovative solution designed for trading perpetual contracts, using a virtual pool of liquidity rather than a traditional on-chain liquidity pool. This model is particularly useful for leveraging price exposure to assets without actually holding the underlying assets in perpetual DEX development.

Pros of vAMM in Decentralized Exchange Development:

• Infinite Liquidity: vAMM does not rely on traditional liquidity pools, offering virtually infinite liquidity for perpetual contracts.
• Capital Efficiency: Traders can take positions with minimal capital outlay, as the liquidity is virtual and not bound by actual assets.
• Low Slippage for Large Trades: Due to the virtual liquidity model, trades can be executed without affecting the price significantly, even for large orders.

Cons of vAMM in Decentralized Exchange Development:

• Complexity of Pricing: The pricing mechanism is more complex compared to traditional AMMs, requiring a deep understanding of how the virtual liquidity is balanced.
• Not Suitable for All Assets: Best suited for derivatives like perpetual contracts; not ideal for all types of tokens or assets.

Example: Perpetual Protocol, dYdX (similar approach).

When developing a DEX, understanding the associated costs is crucial. To get a better idea of the financial aspects, check out our related article - Cost to Create Your Own DEX

C. Proactive Market Makers and Aggregation Models in Decentralized Exchange Development

PMMs and aggregation models represent another approach to liquidity in decentralized exchange market-making. These models aim to provide superior liquidity and more efficient trade execution by actively responding to market conditions and pooling liquidity across different sources.

1. PMM  - Proactive Market Makers

PMMs leverage algorithms that adapt to real-time market conditions, continuously adjusting liquidity based on factors like volatility and trade volume. Instead of relying on a static formula, PMMs respond proactively, adding or removing liquidity to improve capital efficiency and reduce slippage.

Pros of PMM in Decentralized Exchange Development:

• Dynamic Liquidity Allocation: Liquidity is allocated in real-time based on market conditions, which improves trade execution, especially during periods of high volatility.
• Higher Capital Efficiency: By optimizing liquidity distribution, PMMs make better use of capital, as liquidity is concentrated where it is most needed.
• Reduced Slippage: PMMs can decrease slippage by providing liquidity in a targeted manner, ensuring that the order book is always balanced and deep enough to handle trades.

Cons of PMM in Decentralized Exchange Development:

• Increased Complexity: PMMs require sophisticated algorithms and real-time data to work effectively, making them more complex to develop and manage compared to traditional AMMs.
• Potential for Impermanent Loss: Similar to other liquidity models, PMMs are not immune to impermanent loss, especially if liquidity allocation isn’t managed well in response to market volatility.

Example: : Balancer's "Smart Pools" utilize PMM strategies where the liquidity distribution dynamically changes based on market activity. Another example is the dYdX perpetual markets that combine PMM principles with sophisticated order book and liquidity optimization strategies. Dodo is another example of a decentralized exchange utilizing the PMM model. Dodo’s Proactive Market Maker algorithm dynamically adjusts liquidity to optimize price discovery and reduce slippage, offering a more efficient and responsive market compared to traditional AMMs.

2. Aggregation Models

Aggregation models combine liquidity from various AMM protocols and DEXs to provide deeper liquidity and improved price execution. These models aggregate data from multiple liquidity sources, ensuring the best possible price is offered for any trade.

Pros of Aggregation Models in Decentralized Exchange Development:

• Improved Price Execution: By aggregating liquidity from multiple sources, aggregation models provide the best possible trade prices, minimizing slippage and slippage-related costs for traders.
• Increased Liquidity Depth: Traders benefit from aggregated liquidity, ensuring that even large trades can be executed without significant slippage.
• Lower Transaction Costs: Aggregation reduces the impact of high gas fees and slippage, ensuring better overall cost efficiency for users.

Cons of Aggregation Models in Decentralized Exchange Development:

• Complexity in Implementation: Aggregation models require integration with various protocols and liquidity pools, which increases technical complexity for DEX developers.
• Dependency on External Protocols: Relying on third-party DEXs and protocols for liquidity can create risks in terms of security, governance, and centralization of liquidity sources.

Example: 1inch and Matcha are popular aggregation platforms that combine liquidity from various decentralized exchanges to offer better price execution and reduce slippage for traders. These platforms provide users with a seamless experience by routing orders through multiple liquidity sources, ensuring the best possible outcome for each trade.

Related Reading:
For insights on optimizing user experience in DEX platforms, check out our recent article - 9 User Engagement Features in DEX App Development

5 key factors to consider when selecting a market-making model

When building a decentralized exchange, it’s important to know that you don’t have to choose just one market-making model. Many successful DEX platforms combine multiple models to maximize liquidity, accommodate diverse assets, and meet various user needs.

Here are the key factors founders should consider when selecting a market-making model:

1. Trading Pairs and Asset Volatility

Consider whether your DEX will support stablecoins, volatile tokens, or a combination of both.

• Stable Assets: If your focus is stablecoins or tokens with similar values, a CFMM (Curve) is ideal for minimizing slippage and optimizing capital efficiency.
• Volatile Assets: For tokens with larger price fluctuations, a CLMM (Uniswap V3) will be more effective, concentrating liquidity within specific price ranges to improve trade execution.

2. Liquidity Requirements

Understand how much liquidity your platform needs and the type of liquidity providers you want to attract.

• Low-Slippage, High Volume: If high-volume swaps with low slippage are essential (like for stablecoin trading), integrating models like Curve’s CFMM will help.
• For multi-asset strategies, consider adding models like Balancer’s CMMM for more flexibility and diversification.

3. User Experience

Think about how the liquidity structure will impact traders’ experience.

• Price Execution: If your goal is to provide users with the best possible trade execution across different pools, integrating an aggregator model like 1inch PMM will ensure seamless routing of swaps for the best prices.
• Institutional Traders: If you expect large trades, combining models like TWAMM can minimize market impact, allowing for smooth execution of bigger orders.

4. Flexibility and Customization

Evaluate how much flexibility your DEX needs in terms of liquidity provision.

• Customizable Pools: If you want to offer liquidity providers more control over their asset allocations, consider Balancer’s CMMM, which allows for custom-weighted pools. Combining this with other models can offer both specialization and flexibility.

5. Managing Complexity

Understand the technical complexity involved in integrating multiple models.

• Combining models like CFMM, CLMM, and others in a single DEX can offer powerful liquidity solutions, but it requires smart swap routing and integration to ensure liquidity flows smoothly between different pools without unnecessary slippage.

Combining Models for Maximum Impact

Many DEXs leverage multiple models in a single platform to accommodate various asset types, trading strategies, and user preferences. While integrating multiple models adds complexity, the rewards are significant: increased liquidity, reduced slippage, and better market depth.

If you’re looking to combine several market-making models in your DEX, Rock’n’Block - a web3 native DEX development company can assist in navigating the technical challenges, ensuring your platform remains efficient and user-friendly.

Rock'n'Block - Your Web3-Native DEX Development Company

At Rock'n'Block, we specialize in building decentralized exchanges tailored to your unique needs. Whether you're leveraging a single market-making model or combining several, our team has the experience and technical expertise to ensure your platform thrives in the Web3 space.

Why Choose Rock’n'Block for Your DEX Development?

• 15+ Years of Custom Blockchain Development: With over 15 years of experience, we excel at crafting DEX solutions with optimized liquidity management, tailored to your specific market needs.
• 300+ Expert Blockchain Solutions Delivered: We’ve successfully delivered more than 300 blockchain projects, demonstrating our versatility in DEX architecture and smart contract optimization.
• 150+ Blockchain Experts: Our highly skilled team of developers, architects, and security specialists ensures top-notch solutions for your DEX development.
• $1B+ in Capitalization: Our clients’ projects have collectively reached over $1 billion in capitalization, highlighting our ability to drive successful, scalable decentralized solutions.
• 50+ Innovative Web3 Technology Services: From liquidity management to smart contract development, we offer comprehensive Web3 technology services for every stage of your DEX project.

How We Support Your DEX Development

• Single Model DEX Development: Whether you’re looking to implement CPMM, CFMM, or CLMM, our team builds a DEX optimized for the type of assets you trade and your specific liquidity needs.
• Flexible Multi-Model Solutions: For more complex DEX platforms, we help integrate multiple market-making models—such as CPMM, CLMM, CFMM, and PMM—to optimize liquidity, minimize slippage, and maximize market depth.
• Liquidity Optimization: We help structure liquidity pools to ensure efficient capital usage, whether you’re focused on stablecoins, volatile assets, or diverse asset types.
• Smart Contract Development: We specialize in developing smart contracts for decentralized exchanges, tailored to support the unique needs of your DEX and ensuring seamless, trustless transactions.
• Routing & Trade Execution: Whether you're using a single model or multiple, we ensure that trade routing across liquidity pools is optimized for the best pricing and execution.
• Scalability & Security: As your DEX grows, we make sure it scales smoothly, with a strong focus on security to protect both your platform and your users.

Partnering with Rock'n'Block means collaborating with a team that’s deeply familiar with the challenges and opportunities of DEX development. No matter your model or approach, we’re here to help you build a secure, efficient, and user-friendly platform.

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