Talking about why DeFi must choose AMM instead of order book?

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Compilation of the original text: Guo Qianwen, Chain Catcher

0xAlpha

There have been many discussions about AMMs and order books, most of which have focused on the technical part: capital efficiency, price discovery, etc. But few seem to realize that the AMM vs. order book debate is about much more than a technical choice in the financial trading business. Order books are a technology adopted by the "financial aristocrats" (that is, Wall Street) to rule and expand their financial empires. In contrast, AMM is a financial technology of the people, by the people, and for the people!

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Traditional way:

This is common in traditional finance: Exchange-traded liquidity is often provided by a privileged class, the so-called Designated Market Makers. The privileged class usually holds a market maker license and has close ties with the exchange in this name. Because of their license, they usually enjoy a series of privileges and advantages:

1. Information: They can view the order book more deeply (although most people can only see the bid price 1 and ask price 1, if they want to see more, they need to pay extra).

2. Technically: They can run their own trading program on a server with extremely low latency (so-called co-location "hosting") to stay ahead of most others.

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Cryptocurrency centralized exchanges:

While many centralized cryptocurrency exchanges still follow the old traditions of Wall Street, there are some new twists. For example, Bitmex divides the transaction parties into two parties: the order maker and the order taker. The taker pays the taker fee (such as 0.075%), while the maker receives part of the fee (such as 0.01%) as "order rebate".

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DeFi AMM (Decentralized Automated Market Maker):

AMM has almost completely removed the threshold for providing trading liquidity. You don't need to be a professional expert, let alone a "noble". The only skill you need to master is to run a web3 wallet like Metamask,

AMM has unprecedentedly enabled the general public to participate in the liquidity provision of commercial transactions, such as Uniswap, Curve, Balancer, DODO, Sushiswap in the spot trading field, and Deri, Perp, GMX in the derivatives trading field.

Let me summarize the requirements to provide liquidity for a trade:

• In traditional finance, you have both privilege and technology.

• In some centralized encryption exchanges, you don't need to have privileges, but you need to have technology.

• In an AMM-based decentralized exchange, you don't need privileges or technology.

In Case 1, some companies monopolize the industry due to privilege and technical barriers. These "money printing machines" generally earn a lot of money, further strengthening their monopoly position. Essentially, they became a financial aristocracy.

In case 2, although the threshold of privilege is removed, the same group of people in case 1 are still doing business. If you know the big players in crypto market makers, you know what I mean. After all, they've been doing it for decades. Even without the privilege threshold, their technological superiority still puts them at a distinct advantage. This skill advantage is based on order book play. That’s why the order book technology was adopted by the old “financial aristocrats” (aka Wall Street) to rule over financial empires in old lands, extending it into the new realm of cryptocurrencies.

In case 3, usually one can provide liquidity to any counterparty with just a few clicks. This program requires little to no market maker expertise, and it does open doors for the common man.

The rate generated by the USDC_ETH pool on Uniswap generation 3.

Anyone can participate in liquidity provision and share in these rates without the need for market maker skills. (until June 25, 2022 frominfo.uniswap.orgscreenshot taken)

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So what about order books in DeFi?

Currently, the main way to provide liquidity for transactions is AMM. However, there are also DeFi platforms that employ an order book mechanism, of which dYdX is a leading example. In fact, most of them are fake DeFi. Transactions on such platforms usually happen on their own dedicated servers (or AWS servers), just connected to the blockchain network through some "L2 technology". Connecting the matching engine running on the central server to Ethereum through some L2 technology does not make it decentralized. Adoption of the so-called "independent blockchain" (or application chain) announced by dYdX's 4th generation plan is not decentralized either.

Although having a separate blockchain might make it more decentralized since "each validator will run an in-memory order book", it doesn't change the fact that transactions (order matching) happen on off-chain servers . The role of the verifier is only to ensure the legitimacy of the transaction. Such platforms lack almost all the advantages that DeFi projects have: composability, transparency, and interactivity.

And best of all, such platforms are often ruled by the same Wall Street traders as they have always been. In other words, such platforms are nothing more than an extension of the old "financial aristocrats" (aka Wall Street). Just look at who is making the market for dYdX and you will know the answer. The situation will be exactly the same after dYdX migrates to the 4th generation version.

Note that this does not mean that the semi-centralized approach adopted by projects such as dYdX is useless. Platforms that adopt this method can also be excellent, such as Bitmex, Binance, FTX, etc., but they are not DeFi. (Of course, if you want to become an excellent platform, you don't necessarily need to be Defi). These platforms, as well as centralized exchanges, often provide high-frequency trading better than AMMs (this is a basic institutional need)

However, in addition to lacking the typical advantages of DeFi, they also cannot function as a DeFi solution-open the door of the market maker club for people on the street to participate and share the profits. Due to the huge trading volume of dYdX, it generates huge profits for its market makers every day.

But that has nothing to do with you and me outside the noble club. A good example in contrast to dYdX is Deri Protocol, which adopts the AMM trading model: anyone can provide liquidity for derivatives trading and share profits without having to master complex derivatives skills.

Since January 2022, the increase in the net value of LPs in the main pool of the Deri protocol shows that anyone can share in the profits of derivatives market making. (Screenshot taken from info.deri.io, as of 2022-6-25)

This is why DeFi must choose AMM instead of order book as the paradigm of market making.