Replicated Market Makers: Oracle-Free DeFi

TL;DR: Easy, efficient, secure, and oracle-free covered calls in DeFi. Brought to you by Replicated Market Makers.

If there’s one thing that is of tantamount importance to the survival of our trade, it’s liquidity. Just like human beings, markets and economies of scale need liquid(ity) to survive. In the world of DeFi, automated market makers (AMMs) rule the liquidity landscape. Yet, this monolith of a decentralized system can’t seem to find its way to the holy grail: financial derivatives. But why? 

Currently, liquidity providers are given liquidity pool (LP) shares proportional to their contributions, allowing for the replication of financial derivative payoff. Alas, this is highly inefficient. Add in the fact that many systems have the same critical point of failure – continuous price updates from external oracles- resulting in extraordinarily high gas fees and unnecessary system complexity. The anfractuous nature of these systems often result in vulnerability from front-running attacks, among others.  

To combat this issue, innovative work by the trio of Guillermo Angeris, Alex Evans, and Tarun Chitra resulted in the creation of Replicating Market Makers (RMMs). Unlike their counterparts, RMMs do not depend on external price oracles, are not time varying, and are comparatively easy to implement. Potential applications of RMMs allow the possibility to add a new dimension to derivative trading within liquidity markets. Later, I introduce Primitive: a new project taking advantage of RMMs and share my interview with Head of Product, Zach Thielemann. So strap in and let’s dive deep! 

Here’s The Issue

Out of the endless possibilities smart contracts offer, their implementation as automated market makers (AMMs) has been nothing short of game changing. If you’re new to AMMs, I suggest this quick primer

Currently, the most popular AMMs (Uniswap, Balancer, etc.) fall into a family called Constant Function Market Makers (CFMMs). These work by using reserves (provided by liquidity providers, LPs) to execute swaps for traders. This allows for a swap to occur only if it preserves the reserve. In the image below, we can see how Uniswap uses its CFMM formula to keep the product of the reserves equal, both before and after the trade. RMMs are a different take on traditional CFMMs.


Traditional CFMMs work to a LP’s advantage if they wish to subscribe to a mean reversion strategy. This strategy adds liquidity to a CFMM to maintain a constant portfolio weight of assets, satisfying a trading function — meaning this strategy works only if one believes the prices of the underlying token pair will be correlated. 

The giant elephant in the gaudy room of CFMMs? Impermanent loss. I’ve written at length on how impermanent loss works, and why it’s a tremendous detriment to the system as a whole. Unfortunately, CFMMs are not immune. 

CFMMs allow traders to execute at predetermined prices – the same as an options contract. The problem is that shorting an option leads to uncontrolled impermanent loss, visualized as a concave payoff. On the other hand, if you’re long an option (visualized as a convex payoff), external price oracles become a requirement. RMMs assert that for every CFMM concave payoff function, there is a corresponding convex CFMM. As a result, a trading function can be found that ensures liquidity providers a guaranteed payoff.

top: convex payoffs, bottom: convex payoffs, source

The Solution

Compared to traditional on-chain dynamic hedging, CFMMs allow LPs to achieve desired payoffs through passive contribution of capital. Arbitrageurs play the crucial part of maintaining the asset prices within the pool, relative to the market price, and in turn receive profits. Consequently, CFMMs are able to maintain both an ‘oracle-free’ system, and the ability to actively replicate payoffs. Incentives for arbitrageurs are sufficient guarantees for correctly reported asset prices. Arbitrageurs are actively engaged in a zero-sum game with LPs, though this system is not without risks, which I’ll delve into later.

Black-Scholes model of replicated price of covered call, source

The brilliance of RMMs is their ability to be CFMM trading functions whose value matches a desired payoff. The general framework of RMMs allows for the designing of various types of financial instruments such as binary options, call spreads, put spreads, covered calls, capped calls, perpetuals, and more. One important distinction to make is that, although Uniswap v3 is a CFMM and makes use of concave payoffs, it is not a RMM. Uniswap v3 does not outright have the robustness of financial derivatives, such as expiration date, theta (time). Subsequent demonstrations on constructing a Uniswap v3 LP position have suggested the method to be prohibitively expensive.

Data source

An especially noteworthy application of RMMs is replicating the payoff of covered calls. Through the use of RMMs to replicate covered call payoffs, complexity and cost of implementation are greatly reduced. The benefits of RMMs over CFMMs are most clearly visible here: 

  • LPs get the ability to choose when impermanent loss beings
  • LPs have the direct ability to choose their level of volatility
  • LPs earn fees as the pool gets closer to the expiration 

One project that has begun the daunting task of creating a RMM dapp is Primitive. 


Primitive is the first project seeking to build a RMM DeFi ecosystem and market themselves as a spot exchange and derivative protocol. The core team consist of 8 members, led by founder and CEO Alex Angel, along with CPO Zach Thielemann, CTO Matt Czernick, and Head of Research 0xEstelle

The initial product offering will be RMM-01, which will serve as a financial vehicle for covered call replicated payoffs, as well as a decentralized spot exchange. In particular, RMM-01 will concentrate liquidity around the strike price of a given option. As time progresses towards expiration, the concentration of liquidity edges closer to the strike price, creating a quasi-covered call. 

RMM and CFMMs mean reversion strategies may look identical at first glance, given that both have concave payoff results. The difference is that covered calls allow one to take a directional view on future price.

RMM convex curve values assets based on price, volatility, and time, source

In addition, RMM convex curves also vary with different levels of implied volatility, causing it to swap for different costs. Trading in a higher IV curve leads to a higher price of assets bought, and vice-versa.

Liquidity providers are given tokens for their services. It can get a bit confusing keeping track of the many uses, so here’s a chart I put together breaking down the potential usage for Primitive’s liquidity tokens.


A project as ambitious as Primitive certainly doesn’t come without caveats. Team execution thus far has been stellar, and the preliminary work speaks for itself. However, a risk is seen in the possibility that LP fees will not be generated at all. 

This could happen under the following circumstances: 

  • The pool’s liquidity was not balanced 
  • Realized volatility is lower than the curve’s implied volatility
  • Liquidity in a pool is too small for trades to occur
  • Liquidity in the pool does not create enough profitable opportunities for arbitrageurs to trade
  • The pool is not integrated into the DEX well enough to be recognized by arbitrageurs

That said, the team has done plenty of work to secure assets. RMM’s smart contracts have been independently audited by five third party security firms, they have created a $1 million bug bounty on Immunefi. RMMs are a relatively new creation on the scene. So much so that Primitive has yet to launch on Ethereum mainnet. The potential for their growth, paired with multiple clean audit reports, paints an optimistic future for Primitive and their RMM smart contracts. 

The Roadmap with Zach Thielemann, CPO

I had the pleasure to sit down with Chief Product Officer, Zach Thielemann, to discuss the future of Primitive and his vision for RMMs.

Zach provided a unique outlook, highlighting a future where Primitive would offer oracle-free monotonic payoff replication (binary calls, capped calls) for the masses. I imagine traders will definitely salivate over the concept of complete trustlessness, married with complete degeneracy, of course. Initially, he sees RMM-01 as a product designed for more sophisticated DeFi users. In the near term, Primitive plans to offer only ETH/USDC pairings, and gradually open up to more chains and tokens. 

Zach’s endgame? To create a fully decentralized, secure, oracle-free option market that even the most retail trader can enjoy, use, and benefit from. I know what your next question is: “Wen token?” Sorry, but Zach tells me that’s the farthest thing from the core team’s mind right now. He notes that the Primitive team is “focused on developing a methodology more than a product. [They] want to be pioneers in the innovation of decentralized derivatives. Launching a token that doesn’t contribute to the use of the system…isn’t necessarily on our minds right now.” These words didn’t fall on deaf ears; ensuring security and progress, over monetary gains, often ends up being the predictor of future success in web3.

Future Implications

Regardless of what the future holds, Primitive has already made history as the first organization to create a complete ecosystem through replicating market makers. And this is just the beginning. The practical applications extended far beyond covered calls. Existing constant mean market makers like Balancer could be reconstructed to implement RMMs as well in perpetual American put options. Additionally, future research on RMMs may lead to mitigated losses for arbitrageurs, allowing for less capital intensive startup requirements. Similarly, this may lead to the establishment of short positions in CFMMs shares as well as leverage instruments. It’s no question that RMMs are still in their early days, but development and implementation is happening at mind-boggling speeds. Through the release of a series of papers centered around CFMMS, Angeris, Evans, and Chitra and with the work from the folks at Primitive, DeFi as we know it may have changed forever. How lasting will that change be, and to what degree? That remains for us to see.

This report is not investment or trading advice. Please conduct your own research before making any investment decisions. Past performance of an asset is not indicative of future results. The Author may be holding the cryptocurrencies or using the strategies mentioned in this report.

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