Prerequisite Primer — TradFi Market Making
P1 · Bid-ask spread = inventory risk premium
A market maker quotes two prices and earns the — but the spread is not free money. It is compensation for inventory risk: between your buy and your offsetting sell, the price can move against the inventory you're warehousing. Wider volatility → wider spreads. An 's price-impact curve plays exactly this role: it is a spread, set by formula instead of by a trader.
P2 · Delta & gamma
Delta: how your position value changes with price. Gamma: how your delta itself changes. A position that loses faster the further price moves in either direction is short gamma — the classic example is selling a straddle. Remember this shape: value flat near entry, bleeding on both tails. positions have exactly this profile.
P3 · Adverse selection — why MMs lose to informed traders
Counterparties are not random. The trader hitting your quote disproportionately knows something you don't — your stale quote is their profit. Market makers survive by skewing quotes and pulling them fast. An AMM cannot pull its quote: it fills every informed (arbitrage) trade at a stale price, every block. This is the deepest reason LPs underperform.
P4 · The synthesis
An AMM LP is a market maker who: (1) earns a fixed-formula spread (the fee), (2) holds inventory with short-gamma payoff (), and (3) cannot refuse informed flow (adverse selection / ). Whether LPing is profitable is just the TradFi question: do fees collected exceed losses to informed flow?