This episode reveals how Prop AMMs are fundamentally rewriting Solana's market structure, creating hyper-efficient, TradFi-level execution for large-cap assets while pushing traditional AMMs into a specialized niche for the long tail.
Defining Prop AMMs: A New Market Structure on Solana
- Chris Hermida, co-founder of Switchboard, opens by reframing the popular term "Prop AMM" (Proprietary Automated Market Maker). He argues they are more accurately described as Oracle AMMs or Programmable AMMs, as their core function is to use an external price feed—an oracle—to determine asset prices, rather than relying on the internal ratio of tokens in a liquidity pool like traditional AMMs.
- An Oracle is a service that feeds external, real-world data, such as an asset's price on a centralized exchange like Binance, onto the blockchain.
- This shift allows for more accurate, real-time pricing for high-volume assets like SOL-USDC, where price discovery primarily happens off-chain.
- Chris notes that while Oracle AMMs like Lifinity have existed for a while, a recent explosion in their use, beginning in late 2023, has dramatically altered Solana's DeFi landscape.
The Evolution of On-Chain Liquidity: From Passive to Proactive
- The conversation contrasts the "reactive liquidity" of traditional AMMs with the proactive model of Oracle AMMs. Traditional AMMs suffer from impermanent loss, a financial risk for liquidity providers (LPs) when the price of assets in a pool changes relative to simply holding them.
- Oracle AMMs mitigate this risk by constantly updating their prices based on external market data. This allows LPs to provide liquidity with tighter spreads and less fear of being exploited by informed traders.
- Chris explains this results in a better experience for both sides of the market. As he puts it, "from an LP perspective, you know, you're less likely to lose money... And so ultimately it results in tighter spreads for the majority of average users."
- Strategic Implication: This marks a structural shift from passive, algorithmically-defined liquidity to active, oracle-driven liquidity provision, mirroring strategies from high-frequency trading (HFT).
The Catalyst for Change: Why Now?
- Jack questions why this seemingly superior model took until late 2023 to gain dominance. Chris identifies the rise of DEX aggregators, primarily Jupiter, as the key catalyst.
- Aggregators consolidate retail order flow, routing trades to the venue offering the best price. This created a highly competitive environment where Prop AMMs could plug in and systematically out-compete traditional AMMs on price for liquid pairs.
- Before aggregators controlled the majority of user volume, even a superior pricing model couldn't gain enough traction to be viable.
- Investor Insight: The dominance of aggregators like Jupiter is the critical infrastructure piece that enabled this market structure revolution. The battle for order flow, not just liquidity provision, is now the central competitive dynamic in Solana DeFi.
The Shifting Landscape: Data and Key Players
- Jack highlights Blockworks Research data showing a dramatic change in market share for SOL-stablecoin swaps. While established players like Orca and Raydium dominated in early 2024, new, mysterious entities like Humidify, Solfi, and Goonfi now command significant volume.
- It's revealed that Solfi is built by Ellipsis Labs, a well-known Solana infrastructure team.
- However, the teams behind Humidify (currently the largest) and others remain anonymous, adding a layer of intrigue to the trend.
- Jack confirms that a rumor about the team Temporal being behind Goonfi is false, highlighting the secretive nature of this space.
The Secretive World of On-Chain Market Making
- The discussion turns to why these Prop AMM operators remain anonymous. Chris attributes this to the secretive culture of the traditional HFT world, where maintaining a competitive edge is paramount.
- He makes a joke to illustrate the point: "never ask a man his salary, a woman her age, or a DEX aggregator who's behind a certain prop AMM."
- A key operational reason for this secrecy is to mitigate toxic flow—informed trades that are likely to cause losses for the market maker. By operating through aggregators and without public front-ends, Prop AMMs can better protect themselves from being targeted by sophisticated arbitrageurs.
Strategic Implications: The Future of AMMs and Memecoins
- A clear market bifurcation is emerging. Prop AMMs are set to dominate trading for large-cap, liquid assets where reliable off-chain price feeds exist.
- Traditional AMMs, like those on Raydium or Pump.fun, will become specialized venues for long-tail assets and memecoins, where on-chain activity is the primary source of price discovery.
- Actionable Insight: Investors and researchers should view the AMM landscape as two distinct markets. The efficiency gains in large-cap trading are driven by Prop AMMs, while innovation in long-tail asset launches will remain the domain of traditional AMMs and launchpads.
Beyond Prop AMMs: RFQs and Alternative Market Structures
- Chris explores other market structures, particularly the Request for Quote (RFQ) model. An RFQ system involves a trader requesting a price, followed by an auction where market makers compete to fill the order.
- While RFQs exist on Solana, Chris argues they are currently less competitive than Prop AMMs for most retail trades. The need for a user to accept a quote introduces a time delay (optionality), which market makers must price into their spreads, resulting in a worse price.
- However, RFQs may excel in specific use cases, such as very large stablecoin swaps (e.g., USDT-USDC) or other "like-kind" swaps where the primary cost is capital, not price volatility.
Competitive Dynamics: Who Wins in the New Solana DeFi?
- The conversation explores the long-term competitive landscape. Chris posits that the most valuable position is owning the order flow, making aggregators and wallets powerful players.
- While some market-making firms might build their own aggregators, he notes that trading and user acquisition are fundamentally different skill sets.
- For Prop AMM operators, margins are expected to tighten as more sophisticated players, including traditional trading firms, enter the space. The ultimate beneficiary of this increased competition is the end user, who receives better prices.
- Strategic Consideration: The defensibility of Prop AMMs lies in continuous innovation in pricing algorithms and risk management, as spreads will inevitably compress over time.
Solana's Competitive Edge: Is This Replicable?
- Jack asks if the Prop AMM model gives Solana a durable advantage. Chris clarifies that this market structure can be replicated on any chain, but its success depends entirely on where user flow congregates.
- Solana's unique combination of high retail volume channeled through a dominant aggregator (Jupiter) created the perfect conditions for this trend to flourish.
- On EVM chains, he notes that different models, like intent-based systems and RFQs for bridging, have gained more traction so far due to different market dynamics and capital fragmentation.
The Next Frontier: Pull-Based Oracles and Future Unlocks
- Looking ahead, Chris identifies a potential shift from "push-based" to pull-based oracles as the next major unlock.
- A pull-based oracle is a system where users request a price update on-demand, rather than the oracle constantly "pushing" updates. This is far more cost-effective and could enable Prop AMMs to support a much wider range of mid-cap assets, not just the highest-volume pairs.
- He emphasizes that the biggest threat to this ecosystem is not competition, but a significant decline in on-chain trading volume, which would make the entire model less attractive for market makers.
A Critique of Opacity: Are Prop AMMs a Step Backward?
- The episode addresses the criticism that Prop AMMs make Solana's market structure more opaque and "TradFi-like," moving away from crypto's open-source ethos.
- Chris argues that forcing these proprietary algorithms to be open-source would destroy their competitive edge, ultimately harming the end user.
- He concludes that the current structure, while less transparent, creates a competitive environment that results in tangible benefits for retail traders: tighter spreads and better execution. The alternative would likely be less efficient on-chain markets.
Near-Term Outlook: What to Expect by Year-End
- Chris predicts that more Prop AMMs will launch by the end of the year, increasing competition further. He also anticipates that upcoming Solana upgrades will make these systems even more efficient.
- The key trend to watch is whether this model successfully expands from top-tier pairs like SOL-USDC to a broader set of mid-cap tokens, which would signal a deeper and more permanent change in DeFi market structure.
Conclusion
This episode highlights a pivotal shift in DeFi market structure, where proactive, oracle-driven Prop AMMs are delivering superior execution for liquid assets on Solana. Investors and researchers must recognize this bifurcation: while traditional AMMs will serve the long-tail, the future of high-volume trading is hyper-competitive and increasingly sophisticated.
