Optimal Rebalancing in Dynamic AMMs

Abstract

Dynamic AMM pools, as found in Temporal Function Market Making, rebalance their holdings to a new desired ratio (e.g. moving from being 50-50 between two assets to being 90-10 in favour of one of them) by introducing an arbitrage opportunity that disappears when their holdings are in line with their target. Structuring this arbitrage opportunity reduces to the problem of choosing the sequence of portfolio weights the pool exposes to the market via its trading function. Linear interpolation from start weights to end weights has been used to reduce the cost paid by pools to arbitrageurs to rebalance. Here we obtain the $\textit{optimal}$ interpolation in the limit of small weight changes (which has the downside of requiring a call to a transcendental function) and then obtain a cheap-to-compute approximation to that optimal approach that gives almost the same performance improvement. We then demonstrate this method on a range of market backtests, including simulating pool performance when trading fees are present, finding that the new approximately-optimal method of changing weights gives robust increases in pool performance. For a BTC-ETH-DAI pool from July 2022 to June 2023, the increases of pool P\&L from approximately-optimal weight changes is $\sim25\%$ for a range of different strategies and trading fees.