Automated market makers (AMMs) are revolutionizing decentralized finance by allowing liquidity providers to earn yields on crypto assets through liquidity pools. One particularly promising AMM proposal – XLS-30D on the XRP Ledger – offers lucrative opportunities for both individuals and institutions seeking passive income streams.
I recently came across an insightful video by Lewis Jackson where he explores XLS-30D and its income generating potential, with commentary from XRP Ledger creator David Schwartz. In this comprehensive 2200+ word guide, I‘ll break down exactly how AMMs and XLS-30D work, delve into the profit mechanics involved, and showcase real-world use cases demonstrating these "automatic money makers" in action.
A Crash Course on AMMs
Before diving into XLS-30D specifically, it‘s important to understand what automated market makers are and how they differ from traditional exchanges.
In a nutshell, AMMs are on-chain liquidity pools that use smart contracts to facilitate trading without traditional buyers and sellers. Liquidity providers deposit assets into these pools to earn fees from trades that occur.
Instead of using order books, AMMs leverage a constant product formula to determine fair pricing based on the relative balance of assets in the pool. When trades occur, the prices automatically adjust to keep the product constant.
For example, if an AMM pool contains 100 XRP and 5000 USD, the constant would be 500,000. If someone trades 50 XRP for USD, the pool would now contain 50 XRP and 7,500 USD, keeping the product at 500,000. This maintains accurate pricing as assets are traded.
The formula looks like this:
x * y = kWhere:
x = Quantity of Asset 1
y = Quantity of Asset 2
k = Constant Product
So if x or y changes, the other adjusts to maintain kThis mechanism presents some powerful implications:
Precision pricing with no slippage – Trades execute at the exact fair market rate based on the defined formula
Arbitrage enforcement – If external prices diverge, traders can profitably close gaps
No order books / counterparties – Assets are exchanged directly with the pool in one step
By leveraging these attributes, AMMs unlock smooth automated swapping functionality.
XLS-30D – AMM Innovation on XRP
The XLS-30D proposal brings the advantages of AMMs to the XRP Ledger, introducing two liquidity pools along with a unique token called the LP.
The first pool contains issued currencies (fiats and cryptos), while the second contains XRP and the LP token. Anyone can provide liquidity to these pools by depositing assets. In return they receive LP tokens representing their share of the total liquidity.
These LP tokens are particularly interesting because holders can later redeem them to withdraw their portion of assets plus a cut of the fees earned from trades occurring in the pools.
This makes XLS-30D an attractive passive income opportunity. By supplying crypto or fiat liquidity upfront, you can essentially "set and forget" while earning yields from the trading volume over time.
And as adoption of XRP expands, transaction volume and demand for swaps grows in kind.
Interacting with XLS-30D Pools
There are a handful of transaction types that allow liquidity providers and traders to interact with XLS-30D pools:
amm Deposit – Add assets to a liquidity pool to receive proportional LP tokens
amm Withdraw – Redeem LP tokens for underlying pool assets
amm Trade – Swap one asset for another via the liquidity pools
amm Bid – Bid for special privileges regarding trading fees
These transactions facilitate all the core functionality, from supplying initial liquidity to executing swaps to redeeming fees and assets.
It‘s also worth noting that the constant product formula is at work under the hood. When amm trades occur, the smart contract ensures balances stay in their target ratio to enable accurate, slippage-resistant pricing.
Module ensures x * y = k
Controlling Fees for Higher Yields
One exceptionally unique aspect of XLS-30D is the ability for LP token holders to actually vote on and manage the trading fees accrued within their AMM.
This is done via the amm Bid transaction, where participants can bid XRP for the option to alter trading fees. The bids last for 30 days, after which a new auction occurrs.
Not only does this give liquidity providers more control, but they can tweak fees to maximize trading volume and by extension, their own passive yields.
Essentially XLS-30D pools become community-owned banking systems, with members incentivized to optimize profits.
The initial technical specification sets the default trading fee at 0.2%. However liquidity providers can vote to adjust this lower or higher on a monthly basis.
Statistics show even 0.2% performs well compared to alternatives:
Based on this analysis, we could conservatively estimate around $2 million per year in fee revenue if daily volume reached just $50 million. And that‘s at the default 0.2% rate – if liquidity providers voted to increase to 0.5%, Yearly Revenue would scale to $5 million.
As XRP expands across enterprise and institutional usage, volume could quickly exceed these projections. Just look at RippleNet‘s $15 billion per quarter to get a sense of the magnitude possible.
Institutions Can Capitalize on Dormant Assets
While the yields from amateur liquidity providers may seem modest, XLS-30D offers a particularly compelling use case for institutional investors and fintechs.
Banks, payment providers, remittance firms and other large players often have huge stockpiles of "dormant" funds flowing through their infrastructure. XLS-30D finally gives them a way to earn returns on these assets.
By contributing a significant amount of their existing currencies into the liquidity pools, these institutions can collect sizable fees from every subsequent trade and swap.
It‘s basically a workflow to "productize" what would normally be dead money into an ongoing revenue stream.
David Schwartz expands on this institutional appeal during the video:
"If you‘re a financial institution and you want to be involved in issuing stablecoins, or doing transfers between countries, or offering liquidity in a particular currency, or getting paid for payment processing – instead of just taking the money and having it sit there you could put it into one of these pools."
He uses the real-world example of Project Mariana – a liquidity hub connecting banks across the US, Europe and Japan:
"All the banks that are involved in Project Mariana could seed the liquidity pool with euros, dollars and yen. And then every time people trade back and forth between those currencies you‘d get a little cut."
This demonstrates the profound gravitas and efficiency XLS-30D can unlock for global financial networks.
Let‘s analyze the potential economics for an example bank utilizing XLS-30D to "productize" previously dormant funds:
- Bank has $10 Million USD sitting idle related to payment processing
- Contributes this to XLS-30D liquidity pool
- Daily volume in pool is $500K with avg 0.3% trading fee
- Bank would earn $1500 per day or $550,000 per year in fees
- Compared to $0 by letting funds sit idle
So even relatively low liquidity and volume can extract powerful yields on dormant institutional money. As demonstrated above, those figures scale dramatically based on adoption.
Diversifying Liquidity Across Chains
Another point David Schwartz mentions is the potential for AMMs like XLS-30D to enable seamless liquidity and asset movements across different blockchains.
For example, a fintech could launch a token on Ethereum representing a fiat currency like USDC. That USDC could then be added to a liquidity pool on the XRP Ledger via XLS-30D, enabling decentralized trading between XRP and this token.
The organization running the pool may also distribute LP tokens to pool participants, further driving circulation of their token throughout the interconnected crypto economy.
Not only does cross-chain interoperability unlock more diversified earning avenues, but it streamlines workflow efficiencies for institutions operating on multiple chains like Ripple or SBI.
Federated sidechains are another development that bridges AMM functionality across different ledgers and assets:
"The Federated Sidechains amendment allows the XRPL to support tokens representing off-ledger assets. This bridges traditional financial systems and blockchain to unlock capital and make marketplaces more efficient and competitive."
So we could soon see traditional assets like Goldman Sachs Stock made tradable on XLS-30D pools via federated minting and burning mechanisms.
The Risks and Unknowns
Given its novelty, investing in XLS-30D does come with uncharted territory and unknowns. According to David Schwartz:
"I can‘t tell you what the yield is going to be – that depends on too many factors. Trading volume, liquidity levels, what people choose to do with trading fees."
Impermanent loss is also a risk liquidity providers take on when market volatility causes the ratio of assets to change. However, Schwartz notes the XLS-30D design helps mitigate downside:
"This one gives you much less impermanent loss and much more ability to control the parameters to reduce and manage your risks."
There are also complex mechanics related to the LP token auctions that can dramatically impact overall profitability. Experts are still deciphering variable yield based on changing conditions.
However, the core promise remains – deposit assets, receive yield generating tokens, redeem profits. At its simplest, that‘s tough to argue with.
Guaranteed Returns and Protections
According to David Schwartz, a balanced contribution into the XLS-30D liquidity pools comes with assurances that greatly minimize downside risk:
"As long as there‘s a reasonable amount of economic activity, I can guarantee if you put in a balanced portfolio you will always be able to redeem your LP tokens for an amount equal to or greater than the amount you put in."
He attributes this to the mathematical formula underpinning the AMM:
"The product of the amount of dollars in the pool and the amount of XRP in the pool is always increasing, because every time there‘s a trade, there‘s a little cut that goes to the LPs. So if you own a proportional amount when you come back, the amount you can redeem will only ever increase."
This means even in a hypothetical worst-case scenario, you would at minimum break even on your principal. Compared to buy & hold, liquidity providing significantly reduces risk of loss.
As depicted above, the value of your share of the pool will likely grow over time as trading volume accumulates fees. Because volumes and prices are unpredictable, so are yields – but the structure guarantees you won‘t lose money.
For investors and institutions alike, that‘s an excellent value proposition.
How might XLS-30D yields compare to other DeFi opportunities? While variable, we could expect APY in the 10-20% range based on trading volume and fees. This competes favorably against platforms like Aave (4-8% on stablecoins) or Lido (6.7% on ETH) with arguably much more upside.
Of course users must gauge their own risk tolerance – but for long-term passive income, XLS-30D demonstrates promise.
Ongoing Development and Roadmap
XLS-30D was first proposed by developers ArminHolzinger and Ryan Rieger in 2021 under an amendment system to improve features over time.
While still in testnet, the contribution format specification was updated in 2022:
"Contribution Strings replaces Contribution Fields to simplify usage and provide a uniform format that works for any currency bridged via Federated Sidechains."
This demonstrates just one way functionality is actively being enhanced based on community feedback.
There is also discussion around expanding the initial two pools into additional isolated pools for particular currency pairs. So we could eventually see standalone markets just for USD/XRP, EUR/XRP or BTC/XRP with their own custom fees and parameters.
All this means XLS-30D and its income generating design is clearly still in its infancy – with a promising roadmap ahead as adoption grows.
Tokenomics of the LP Token
The LP token that liquidity providers receive has intrinsically attractive economics. As David Schwartz summarizes:
"For me the thing about the LP token is it gives you this leveraged way to play the increasing demand for XRP and increasing demand for dollars on the network."
This leverage comes from the fact that the token is redeemable for a % claim on the underlying assets.
As the pools grow, each LP token accrues more value. If the total liquidity doubles, your tokens double what they can be redeemed for. Adding in the fee accrual makes a perpetually appreciating design.
There are also mechanisms to incentivize longer term holdings and limit potential dumping:
"There‘s a redemption delay on them that says if you want to redeem them right away you‘ll pay a penalty that goes into the pot for people that are still holding."
This cuts out short-term speculators to reward loyal liquidity suppliers.
Counterarguments and Considerations
Some crypto enthusiasts argue relying on centralized exchanges is risky compared to non-custodial DeFi protocols. However AMMs have tradeoffs to weigh:
Order Book Depth – Large exchanges facilitate bigger trades without slippage
Asset Security – Institutional custody solutions minimize counterparty risk
Anonymity – No KYC mandatory for DEX users
For large players like banks and fintechs, AMM advantages around capital efficiency may outweigh decentralization purism.
There are also transparent measures in the XLS-30D design that safeguard user funds:
- Requires multi-signature checkout
- Circuit breakers halt malicious withdrawals
- Public pool data enables auditability
So there are checks and balances against both internal and external risks.
Conclusion: Passive Income Potential
AMMs like XLS-30D herald the next evolution of fintech – where we as users collectively provide the financial rails for blockchain commerce. We‘re not just passive token holders anymore, but active liquidity suppliers powering economic activity while earning yields on our assets.
Despite its complexities, I‘m enthused and slightly in awe of what XLS-30D symbolizes. Every other AMM seems intent on namedropping obscure mathematical formulas to appear cutting edge. But XLS-30D actually makes that equation intrinsically rewarding for us. Our balances can now compound simply by letting cryptofinance operate as intended.
Special thanks is owed to Lewis Jackson for his breakdown, along with David Schwartz for pulling back the curtain on how revolutionary this idle income technology can be. I firmly believe we‘ll look back on this primitive smart contract architecture as a pivotal moment that set dominoes falling toward a more decentralized and participatory economy.
Even in its nascent form, I‘m excited to watch this project develop and hopefully supply liquidity once functionality goes live. Because I for one welcome our new automated money making overlords.