Correlation Trading Pairs Will Drive AMM into Global Financial Markets

Odaily Planet Daily reports that founder Hayden stated on the X platform that correlation trading pairs are forming. The top five tokenized SPY trading pairs serve as "bridge" trading pairs connecting other common base trading pairs, primarily linking tokenized stocks with high correlation. This type of market features globalization, programmability, low costs, and operates around the clock.

Founder Hayden stated on the X platform:

I have been working on the frontier of DeFi for nine years. It is a fascinating field with infinite depth and the potential to transform capital markets.

I have always believed that AMM has tremendous potential, but one question has persisted over the past decade: can this new market structure truly become the core engine of all financial markets?

After years of evolution and development, the path for AMM to achieve global dominance is becoming increasingly clear. To explain this, we need to start from 1976.

Tokenization changes market makers.

This month marks the 50th anniversary of the establishment of index funds. When Jack Bogle launched the index fund in 1976, he hoped to raise $150 million but ultimately only raised $11.3 million. Competitors called it "Bogle's folly" and posted posters claiming that index funds were un-American. They believed that a fund that made no decisions could not outperform professionals who were paid to make decisions. Today, the majority of U.S. fund assets are allocated to passive investment tools.

I have been thinking about this lately because the "folly moment" of tokenization is coming to an end. The U.S. Securities and Exchange Commission has approved the trading of tokenized stocks on Nasdaq and the New York Stock Exchange. The DTCC, which handles almost all securities settlements in the U.S., also conducted a live trial of tokenized trading in July. Almost all related activities are described in the same way: viewing tokenization as an infrastructure upgrade.

The same market, faster, cheaper, and always open. These statements are all correct, but I believe that the framework of infrastructure upgrades obscures larger changes. Tokenization enables programmability in the market, changing the existence of the market, market makers, and the objects of market trading.

In 2018, I created an automated market-making protocol. Anyone can deposit two assets into a shared liquidity pool and earn fees from each transaction, while prices adjust along the curve as users buy and sell. It has been operating autonomously since its launch, with a cumulative trading volume exceeding $4.6 trillion, and has pushed the share of decentralized exchanges in spot trading from less than 1% to over 20%.

As AMMs like this continue to evolve, their liquidity has formed a pattern that most financial markets have yet to notice: correlation trading pairs.

The easiest area to achieve results.

To succeed in all areas, one must first succeed in a specific area. AMMs have found a product-market fit in long-tail markets because most assets previously did not attract the attention of professional market makers. On this platform, anyone can create a market with a single trade, and issuers and early supporters can become the first liquidity providers.

Subsequently, stablecoin trading pairs emerged. For example, with USDC/USDT, a good passive strategy can approach optimal levels, and the lower capital costs are sufficient to cover the gap. This is also why professional trading firms no longer participate in market-making for these stablecoin exchanges, as passive AMMs have lower costs.

High profits and lack of competition.

Traditional financial markets are completely dominated by market-making firms. These firms integrate capital, trading strategies, execution technology, settlement, and distribution into a vertically integrated business. There are reasonable reasons for this structure: assets exist in mutually independent systems, settlement speeds are slow, and each function requires someone to complete it, so one institution takes on all functions.

When the scale is large enough, all fixed costs can be covered. Citadel Securities handles about 25% of U.S. stock trading volume and generated a record net trading income of $12.2 billion last year with about $21 billion in trading capital.

Most people view these numbers as proof of the effective operation of the system, while I see them as a manifestation of market entrenchment.

Breaking the business bundling.

Blockchain introduces competition at all levels, breaking apart businesses that were originally bundled together. Trade execution is done through code, and custody and settlement become shared services accessible to anyone. Tasks that previously required proprietary infrastructure can now be accomplished with open-source software.

In AMMs, capital is a scarce input, and the advantage belongs to those who can hold inventory at the lowest cost. Trading firms need to achieve high returns to cover their operating expenses, so liquidity providers willing to accept lower returns can gain a competitive advantage. Most market makers will hedge all price exposure, and hedging incurs costs, so investors who already hold related assets can take on this exposure for free. The capital cost for asset issuers is negative because issuers typically need to pay professional market makers to provide liquidity for their new assets.

In short, DeFi and AMMs lower the barriers to market-making, opening the market to more participants. Their advantages may come from various sources, such as lower capital costs, willingness to take on inventory exposure that professional institutions typically hedge, or even directly from the asset issuers themselves.

But it all hinges on one question: can automated strategies perform well enough to support this system?

Liquidity follows correlation.

Not long ago, I had a call with one of the largest institutions in finance. They asked what the most common base trading pairs in DeFi are. I explained that Ethereum-based assets typically trade with ETH, Solana ecosystem assets usually trade with SOL, and stablecoins form trading pairs with each other, with only a few high liquidity trading pairs acting as bridges between these clusters.

This pattern was not designed by anyone but formed naturally, partly because when the assets held by liquidity providers move in the same direction, their performance is usually better. Correlation means that liquidity providers face lower inventory risks, allowing them to deepen liquidity. As assets are tokenized, the world's largest markets will also reorganize in the same way.

Traditional markets cannot do this at present. Due to necessity, the vast majority of settlements in traditional markets are conducted in U.S. dollars. Assets exist in mutually isolated systems, and fiat channels like SWIFT and Fedwire serve as the glue that holds the entire system together. But blockchain is a more expressive glue. Once assets are tokenized, they can share the same settlement layer, allowing any asset to trade directly with other assets.

NVIDIA/USD can transform into NVIDIA/SPY, and then connect to USD through SPY/USD as a bridge. Oil companies can trade with crude oil ETFs or tokenized crude oil. Private credit can trade with tokenized government bond funds. Tokenization can also enable markets that span different asset types, which is extremely difficult, if not impossible, for traditional financial infrastructure to achieve.

Delta neutrality is an inefficient approach.

Traditional market-making firms often try to achieve "Delta neutrality." This is a way for traders to minimize non-dollar risk while pricing in dollars. When making markets for volatile assets, they often incur costs through options to reduce non-dollar risk, which is one of the higher-cost aspects of traditional market-making.

Connecting low-volatility "correlation trading pairs" with a few high-volatility "bridge" trading pairs can bring multiple efficiency improvements. The most important point is that if market makers indeed wish to hold the underlying correlated assets, then the market-making costs will be lower and the efficiency will be higher.

The higher the correlation between trading pairs, the smaller the gap between passive AMM strategies and the most complex active strategies, making it easier for passive strategies to compete with lower inventory costs.

Specifically, if someone is long on NVIDIA, they are likely also long on SPY. Compared to NVIDIA/USD, the efficiency gap between passive AMM strategies and active strategies for NVIDIA/SPY is much smaller.

Connected liquidity.

If stocks trade with SPY, then all trades that start or end in dollars will route through the same trading pair, namely SPY/USD. These bridge trading pairs still require high professional capability, but their numbers are much smaller, and the trading volume they carry is large enough to warrant resource investment from professional institutions.

DeFi has already proven this. ETH/USDC is one of the deepest on-chain liquidity markets because every cluster routes through this trading pair. Passive liquidity providers supply liquidity for correlation trading pairs, while active liquidity providers compete around bridge trading pairs.

Investors can still buy and sell all assets using dollars, as trades will automatically route through multiple liquidity pools. Liquidity will concentrate in the lowest-risk areas, rather than being forced to remain in places constrained by traditional infrastructure. This will drive the deepest markets toward correlation trading pairs, which is precisely where AMMs already have an advantage.

Correlation RWA trading pairs already exist.

On-chain correlation liquidity initially came from crypto-native assets. However, the first correlation markets for tokenized stocks have already emerged: ten tokenized stocks are trading with SPY in liquidity pools on the Robinhood Chain.

In the first 12 days, these liquidity pools achieved a trading volume of $33 million, with over 11,000 users participating in trades, many of which occurred during U.S. market hours. Some trades directly exchanged one stock for another without going through dollars.

Notably, we are also starting to see Memecoins paired with "correlated" stocks, such as pairing Elon-themed Memecoins with Tesla stock and hotdog-themed Memecoins with Costco stock. It is still unclear how much correlation they have in terms of price, but I think "feelings" can also be considered another form of correlation.

Success will be achieved.

Correlation trading pairs are just one part of it; the other part is the design and customization of AMMs.

v4 Hooks support comprehensive market customization, which can significantly improve returns for liquidity providers. For example, our recently released DualPool Hook allows passive AMM funds to earn lending yields when they are not used for exchanges.

Although the trading volume has reached about $4.6 trillion, I believe AMMs are still in their early stages, and there are many paths to enhance their competitiveness in the future. Internal teams, partners, and other participants in the ecosystem are building many solutions to improve returns for liquidity providers. More content will be released soon.

In 1976, the argument against index funds was that a fund that made no decisions could not outperform professionals who were paid to make decisions. Fifty years later, funds that make no decisions have outperformed about 90% of professionals. More importantly, index funds have made investing more accessible and improved the lives of ordinary people. I believe that passive liquidity will follow a similar path to success, generating a greater impact by significantly lowering the barriers to creating and participating in markets.

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