Tick
In order to automate the Orderbook through ALD, a fixed Tick Size is used. This has algorithmized rules, with different Tick Sizes depending on the price. To understand this, Understanding CPMM of a Swap is needed first.
In typical Swap trading using the equation x * y = k, small trades entail minimal price fluctuations, while larger trades induce more significant price movements. Stablecoin swaps, on the other hand, generally employ the equation x + y = k, resulting in smoother price movements. Thus, the former method sees price fluctuations dependent on liquidity size and order size, while the latter method sees clear trade limits based on liquidity pool size.
Therefore, in other existing swaps, the liquidity size represented by the constant value k maintains a fixed value, so instead, it has a price discovery mechanism that causes the price to fluctuate rapidly. These rapid price fluctuations directly cause trading losses to traders. This relies on the quantity of tokens in the pool, rather than the value of the token being agreed upon through trading by multiple market participants in an actual market. Since the funds deposited in the liquidity pool are a portion of the total token circulation of the token, it is difficult to determine its scarcity in the actual market, so the price could be easily manipulated with just a single transaction for malicious purposes. This has caused secondary problems in the DeFi ecosystem.
Therefore, to break existing conventions, conduct stable and reasonable transactions, and discover reliable prices, it is necessary to separate the correlation between the proportion of liquidity tokens and the price. An Orderbook mechanism is needed to perform the price discovery process through matching transactions that occur in the actual market, rather than a ratio between the quantities of tokens that anyone can easily manipulate. To operate this effectively in an on-chain environment, automation is necessary, and for this, the algorithm must be used. A fixed tick size based on this is needed.
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Price movements in the market are driven by market demand occurring within the price range presented in the orderbook. Therefore, regardless of liquidity size or order size, it must move within the suggested price range. For this purpose, when distributing liquidity to the tick book through ALD, if the tick interval is too tight, the liquidity is divided into small pieces and the default depth of liquidity allocated to each tick from the vault becomes shallow. This means that there is less liquidity allocated per tick, which means that ticks can move easily even with small transaction sizes. This creates larger price fluctuations and causes greater price slippage, so it is important to determine the appropriate tick size.
Tick Size
The Tick Size correlates with price. The method for determining Tick Size based on price range utilizes the fourth digit from the front of the price number uniformly. For instance, if the current market price is 1500, the Tick is a 4-digit number, with the last fourth digit being 1. If the price is 150, it's a 3-digit number, with the fourth digit being the decimal point, resulting in 0.1. Similarly, for a price of 15, the Tick is 0.01, and for 1.5, it's 0.001. Consequently, the same Tick Size applies to price ranges with the same number of digits. For instance, if the market price is 1001, all prices up to 9999 have the same Tick Size.
| Price | Tick Size |
|---|---|
| … | |
| < 0.0001 | 0.0000001 |
| < 0.001 | 0.000001 |
| < 0.01 | 0.00001 |
| < 0.1 | 0.0001 |
| < 1 | 0.001 |
| < 10 | 0.01 |
| < 100 | 0.1 |
| < 1000 | 1 |
| < 10000 | 10 |
| < 100000 | 100 |
| < 1000000 | 1000 |
| < 10000000 | 10000 |
| … |
Tick Range
The tick range is the number of ticks that can be generated with the tick size determined by the price. The tick range is always created at a maximum of 9999 or less depending on the price range through a fixed tick size. Limit orders have no special impact because they trade at a fixed price, but market orders have tick ranges that vary depending on the market price at the time of ordering. For example, if the current price is 1500, the tick size is 1, and the tick range applied to orders until the price digits change is 500, from 1500 to 1000. If the number of digits in the price changes thereafter, the tick size is recalculated, so 9999 ticks are created based on a tick size of 0.1 from 999 to 100. In this way, the tick range is the number of ticks targeted for a specific spell while the digits of the price's number are maintained.
Tick Liquidity
In Automated Market Makers (AMMs), it can be understood that the Tick Size varies depending on the size of the liquidity or the size of the transaction to be executed compared to the liquidity size. When liquidity is abundant, the Tick Size decreases, resulting in ticks being placed at tighter intervals, thus reducing price movements. Therefore, trading in pools with low liquidity or executing large-size trades may lead to larger Tick sizes, causing prices to change sharply and resulting in increased price slippage.
However, it's essential to understand that the concept of ticks does not officially exist in CPMM but is used here as a metaphorical expression to aid understanding. In reality, all the liquidity within a single liquidity pool is allocated for a single trade. On the other hand, in the Orderbook automated through ALD(Automated Liquidity Distributor), transactions are made within a tick range determined by a fixed tick size, which can be easily understood if you think of each tick represented by the price as a liquidity pool with a fixed exchange rate.
In other words, it can be imagined that according to the price corresponding to each tick, several swap pools that have fixed exchange rates that can be traded at that price are created, and each pool has liquidity allocated from ALD. Therefore, because the liquidity allocated to each tick can be traded at a fixed price, price slippage is reduced. Therefore, ticks move only after sufficient liquidity for each tick has been exhausted, thereby lowering transaction costs and increasing transaction efficiency.
However, while trading according to predefined ticks in an order book has several advantages, the mechanism of using reserved liquidity from the Vault via ALD operates similarly to swaps. In an automated order book, the tick size does not vary depending on the liquidity size, but the liquidity placed for each tick placed through ALD decreases or increases.
This implies that, similar to swaps, automated order books may also be affected by liquidity size, potentially leading to price slippage. As price slippage is closely correlated with liquidity and trading costs, reducing or eliminating it requires either quickly depleting liquidity or consuming more gas. Maintaining a consistent liquidity size requires accepting the dilemma of facing significant price slippage.
In an automated order book facilitated by ALD, unlike traditional order books, insufficient liquidity does not result in orders drying up and the order book becoming empty. Instead, the liquidity allocated from the Vault through ALD diminishes on a per-tick basis. Consequently, when liquidity is abundant and there is more liquidity per tick in the order book, larger volumes are required to deplete the liquidity in each tick, leading to slower price movements. Conversely, when liquidity is scarce and the liquidity allocated per tick decreases, order fill would occur more rapidly, accelerating the depletion of liquidity per tick, and thus causing ticks to move faster, indicating rapid price movements.
However, here arises a difference with Swap. In an Orderbook system, as each tick cycles, if there are pre-ordered limit price orders while the price is moving, liquidity that can be utilized at that tick increases as it flows in from the outside. This additional liquidity supplements the basic liquidity allocated from the vault through ALD for that tick. Essentially, the increase in available liquidity at that tick means that a corresponding amount of liquidity needs to be depleted for the tick to move, resulting in slower price movements. Therefore, in an Orderbook system, this mechanism allows for a more faithful reflection of market logic in price movements, enabling more delicate price discovery reflecting market demand.