first level title
Why DeFi is the trend
secondary title
CeFi crisis of trust
FTX, as the second largest encryption ecosystem in the industry after Binance, suffered a run in a short period of time, and a sudden thunderstorm shocked the entire cryptocurrency world.
We should re-examine the risks of CEX. Returning to the essence of Crypto, every participant should seriously think about a question, is there any fundamental problem in the encryption ecosystem supported by centralized exchanges?FTX's thunderstorm is by no means a failure of Crypto, it just reflects the fragility of the centralized financial system.
FTX regards itself as a bank, uses part of its reserves to meet the usual withdrawal needs, misappropriates funds to provide credit loans for strongly related parties, and seriously lacks risk control, which shows that some asset management platforms that adapt to the traditional financial system, CEX and speculative institutions are lacking What bizarre operations can be done in an environment of regulation and relying on self-discipline.The second largest exchange in the cryptocurrency world, FTX, whose brand image is compliance, security, and good reputation, collapsed within a week. Nothing can better demonstrate the fundamental problems of centralization——。
Crypto provides everyone with a decentralized, free, open, and censorship-resistant environment and infrastructure, and many centralized entities choose to use this environment for evil. The decentralized system empowers everyone to participate freely, freely interact and supervise. Everyone is important to the decentralized system. Because of this, everyone should work hard to avoid similar incidents from happening again, because the large centralization Physical thunderstorms are a huge damage to the entire Crypto ecology.
secondary title
Trust costs and optimism bias
💡 FTX is not the first centralized exchange to take a hit, nor will it be the last. In the short course of Crypto’s development, there have been thunderstorms in centralized exchanges such as Mt.Gox, Flexcoin, Bitstamp, etc., and recently Celsius, BlockFi, FTX, etc. have gone bankrupt. Why do users still choose Crypto after so many thunderstorms? believe?Due to the cost of trust and the existence of optimistic bias, the public will continue to look for the next CEX that they believe in.
This paper defines the cost of trust as the cost that people need to pay to maintain trust and the loss caused by dishonesty.
The original design purpose of the blockchain is to solve the trust problem, how to reach a consensus without the endorsement of a centralized entity. Achieving trust itself under the existing framework has costs, because running a decentralized public chain requires all participants to continue to provide the system with the resources needed to achieve trust, such as machine resources and network resources. These costs It needs to be borne by the users of the public chain. This is a self-consistent economic system. In order to obtain sufficiently decentralized, anonymous, and secure services, people pay a certain fee for the entire system.The biggest contribution of the public chain economy on the issue of trust is to make the cost of trust explicit, which allows every participant to clearly know that trust has a cost, and the fees paid by users can support the operation of the entire system.
Under this mechanism of action, people clearly know that it is extremely difficult to produce untrustworthy behaviors (such as changing contracts on the chain, attacking the public chain, etc.) technically, and the system is robust.
However, in managed CEX, the distribution of trust cost is extremely uneven, and only when the CEX is thunderstorm, users will really bear the trust cost. In fact, every centralized exchange has a trust cost due to its opacity and unverifiability, but the trust cost will not appear during its normal operation. Centralized exchanges do not need to pay trust costs in advance, because as long as users choose to believe, the cost to maintain trust is very small, but the loss caused by dishonesty is huge, and the loss is after the fact. Users will not Immediately experience the cost of trust you are bearing.
Due to the trust cost of CEX with this structure, coupled with the widespread optimism bias, the public will still make their own judgments and choose the next centralized one that they think is no problem after experiencing thunderstorms in exchanges exchange。
secondary title
DeFi is the only solution to the trust problem
Centralized finance guarantees the rights and interests of users by introducing strict supervision, but this is only a transfer of power and cannot solve the problem. We all know that the SEC and the Federal Reserve have unimaginable control and influence on the financial market.If you do not want to introduce more influential centralized entities, such as sovereign governments, global regulatory organizations, etc., then DeFi will be the only solution to solve the trust problem. Let the public chain carry financial activities, and use cryptography to ensure the security and transparency of the ledger.
Transferring the right to choose to users, and keeping their own wealth by keeping private keys, decentralized financial activities will be a paradigm change for the entire financial system.In the last few rounds of bulls and bears, centralized exchanges occupied an absolute dominant position. In the face of huge panic, people can only transfer funds to cold wallets. When the popularity of transactions increases, they can only choose centralized exchanges.
In the last round of bull market, the experience of DAPP has been improved unprecedentedly. The trading experience of decentralized exchanges is not much different from that of centralized exchanges. In terms of the transaction depth of mainstream currencies, Uniswap’s WETH/USDC pool’s The trading depth even exceeds that of centralized exchanges.
image description
ETH-USD trading pair market depth comparison (data source: Uniswap)Most importantly, the cost of trust in DeFi is lower.
Although the existence of network fees increases the friction cost, the trust problem is solved by the public chain, and the trust cost of the whole system is completely explicit. The uncustodial service makes short-term runs almost impossible, and the uncertainty of the whole system will follow. decline.DeFi Summer, also known as DeFi 1.0, is full of various high APY projects in the market, and the entire outbreak is also driven by high returns.And we believe that the real DeFi 2.0 will not be driven by high returns, but will return to the essence of Crypto
, driven by the characteristics of DeFi itself being uncustodial, transparent on the chain, and resolving trust, this will be a new narrative:
The paradigm shift brought about by DeFi follows the code as the law, which brings many problems on the user threshold, MEV, and various security problems. The solutions to these problems will be continuously optimized, but the problems brought by the new paradigm will be As it continues, the development of DeFi will be a long way.
secondary title
Control your own assets, don't be an ostrich
💡 In economics, the ostrich effect refers to the phenomenon that investors selectively ignore negative information.
The FTX thunderstorm has deeply impacted everyone. After experiencing the FTX thunderstorm, don’t ignore the risks of centralized entities. Start by controlling your own assets and weaken the influence of centralized entities. When the assets are transferred to the wallet, you have truly entered the world of Crypto, and you are truly in control of your assets. The threshold for learning to use DeFi is high, but when you learn to use DeFi protocols, such as trading tokens with DEX and lending assets using lending protocols, you will get rid of your dependence on centralized exchanges.
After experiencing the FTX storm, ordinary users should also learn to use at least one DEX to do transactions. News is flying all over the sky. Instead of transferring back and forth in opaque centralized exchanges, it is better to use DEX to solve transaction problems once and for all. At the same time, you will find that in In the world of DeFi, there are not only DEXs.If it's not your private key, it's not your money。
The status quo and development trend of DEX
Current status of DEXs
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I think that in ten to twenty years, decentralized exchanges will surpass centralized exchanges in size. —— Binance Founder, Changpeng Zhao
Can DEX replace the function of CEX at this stage?
The answer is, it is absolutely possible. From trading to pledge interest to fiat currency deposit and withdrawal, there are corresponding DEX or protocol to provide functions. There are Moonpay, Transak, and Wyre in terms of fiat currency deposits and withdrawals, and many DEXs have access to their services; there are a large number of protocols based on DEXs that provide pledge interest-earning services, and there are many DEXs that come with pledge interest-earning services.
From the perspective of product functions, mainstream DEXs such as Uniswap, Pancake, DODO, etc. all support the chart function, and the front-end built-in K-line tool. 1inch, 0x Protocol, DODO, Tokenlon, Paraswap, etc. have all launched the limit order function, which is similar to the pending order of CEX, and users can pre-set the transaction price. The gap between DEX and CEX in terms of product functions is already very small.DEX is undergoing rapid iteration and evolution. Whether it is product experience or liquidity, DEX has become more and more mature.
data performance
DEX accounts for between 10% and 30% of the total spot trading volume, and DEX is still catching up with CEX. Compared with 11.79% in October, it increased to 16.84% as of the 15th, which is somewhat related to the FTX thunderstorm.
image description
In the past 30 days, some mainstream DeFi protocols, the number of users and the number of on-chain transactions have all experienced double-digit growth. It can be seen that due to the impact of the FTX thunderstorm incident, DeFi applications have ushered in significant user growth. At the same time It also indirectly stimulates on-chain transactions.
Data source: Nansen
As of 2PM UTC+8 on November 16, the 24h trading volume of Uniswap V3 surpassed OKX, ranking third in CEX, second only to Binance and Coinbase.
Data source: Coingecko
first level title
The development trend of DEXDEX weekly briefWe have been tracking the product dynamics and market dynamics of DEX for a long time, through
form to the market. In the long-term market tracking, we have discovered some important development trends of DEX. Next, we will analyze these long-term trends in depth, and discuss why these trends appear from the first principles.
Liquidity on routing aggregation chain
💡The routing algorithm will become more and more efficient, the degree of aggregation of on-chain liquidity is increasing and will continue to increase, on-chain transactions will integrate all liquidity, and the potential of on-chain liquidity far exceeds that of centralized exchanges, which will improve the overall System transaction efficiency.The biggest advantage of on-chain liquidity is that it can aggregate with each other, which is also a natural feature of DeFi. Any contract or individual can directly interact with the liquidity pool, and the liquidity of DeFi is integrated. The routing algorithm is the bridge that aggregates the liquidity on the chain. The routing algorithm of each DEX or aggregator may be different, but
The core principles are the same. When a user makes a transaction request, the routing algorithm will calculate the optimal transaction path, and interact with multiple liquidity pools to achieve better transaction prices and lower slippage.This trend will be long-term, because access aggregation functions or self-developed routing algorithms will bring better prices, and users are sensitive to prices. This market competition will force more and more DEXs to use routing to aggregate on-chain fluidity。
image description
Today's DEXs are all connected to aggregation functions, some are connected to aggregators, and some are self-developed routing algorithms. The boundary between aggregators and DEXs has become blurred. Image credit: Messari
In the long-term observation of the DEX market, we found that the competition for routing aggregation is becoming more and more fierce, and more and more DEXs, aggregators, and wallets are aggregating with each other, which makes the degree of integration of liquidity on the chain higher and higher. And there are many ways of aggregation, including aggregators accessing the liquidity of DEX, DEX accessing aggregators, DEXs aggregating other DEXs, wallets, DAPPs integrating DEXs or aggregators, and cross-chain aggregation.
From the perspective of aggregators, 1inch, Matcha, and 0x Protocol are the leading aggregator protocols. Since the beginning of the year, many DEXs have integrated their APIs, such as Woofi, Chainge Finance, Wirex, Aurora, etc. integrated 1inch; Bancor, DODO etc. integrate 0x. Aggregators are also constantly increasing the number of DEXs they access, such as 1inch accessing Babyswap, Elasticswap, Kyberswap, etc.; 0x accessing Balancer, etc.; RoketX accessing Paraswap, etc. Many newer aggregators are also doing well, such as Atlas DEX, which focuses on cross-chain aggregation transactions, and RocketX, which aggregates centralized exchanges.
DEXs using aggregation functions are increasing. For example, Sushiswap launched Trident at the beginning of the year, accessing aggregators and aggregating the liquidity of DEXs, and then upgraded the routing algorithm; Jupiter aggregated the liquidity on the entire Solana; Canoe Finance integrated DODO’s routing Aggregation algorithm to realize the aggregation function.
The integration of DEX liquidity by wallets and DAPPs is also increasing. Routing aggregation essentially integrates the scattered liquidity on the chain. Interact with liquidity.
Introduce professional market makers and provide RFQ functions
💡 A large part of CEX's liquidity is provided by professional market makers, while DEX uses the RFQ function to inquire from market makers, allowing professional market makers to become counterparties and provide greater liquidity.
Why serving market makers is the trend? Professional market makers provide a large amount of liquidity for the market, but due to the high transaction costs on the chain, it is difficult for professional market makers to give full play to their advantages. Therefore, if DEX wants to surpass centralized exchanges, how to provide market makers with better solutions and attract more professional market makers to make markets is an important part.
For professional market makers, on-chain market making is mainly a matter of cost. If the order book is the best choice under the frictionless situation, and AMM is the best choice under the high cost on the chain, then the RFQ function is between the two, most of the RFQ functions will be signed by the private key in the off-chain After completing the inquiry process, both parties confirm that the transaction will be carried out on the chain. The transaction cost will be reduced and the transaction efficiency will be improved by means of off-chain signature and polling. However, the introduction of the off-chain inquiry process will inevitably lead to certain trust issues. The focus of RFQ functional design. In addition to making markets through the RFQ function, professional market makers also actively adapt to the market-making model of on-chain liquidity pools, such as Wintermute and Wootrade.For users, the core experience brought by the RFQ function is less gas fee or no gas and resistance to MEV attacks
Cowswap, Hashflow, 0x Protocol, Tokenlon, Matcha, DODO all have RFQ functions. The RFQ function of Cowswap is called Batch Auction in its own expression. The user authorizes a token transfer, and then signs the transaction information off the chain. After confirming the signature information, the Solver will calculate the optimal solution based on all orders received. Then report to the protocol for selection, and the protocol selects the optimal solution to be executed on the chain, and the competition mechanism is used to ensure that the Solver will not do evil. Hashflow is also an exchange that focuses on RFQ functions, and screens market makers through an access review mechanism. 0x, Matcha, Tokenlon and DODO provide typical RFQ functions, and have no special design for off-chain trust issues. In our market observation, more and more DEXs are introducing RFQ functions. For example, Matcha and DODO are both RFQ functions launched this year. Sushiswap also launched Gasless transactions this year, which is actually an RFQ function. The DEX with RFQ function has access to more market makers, such as Hashflow newly accessing GSR, Ledger Prime and Kronos. In short, more and more DEXs have introduced the RFQ function, and more and more market makers have joined in.
secondary title
Continuously improve market-making algorithms and market-making experience to pursue higher capital efficiency
💡Liquidity pool is a native on-chain solution, which is the main battlefield of DEX. Starting from AMM, all major DEXs are continuously optimizing their market-making algorithms to improve the capital efficiency of market-making.
capital efficiencyThe launch of AMM is a disruptive innovation. Everyone can make a market to provide liquidity, which increases the potential upper limit of liquidity on the chain, but there is a problem of capital efficiency in AMM.Capital efficiency measures how to provide higher trading volume with less TVL, that is, how to support higher trading volume with the same TVL, which means lower slippage and higher market depth for trading experience.
We have demonstrated the aggregation of on-chain liquidity in the previous section. Under the trend of market liquidity tending to be integrated, the competition of DEX is direct and fierce. Who can make the market more efficiently and who can occupy a larger share in the aggregation? market share。
Market making curve legend (source: Uniswap, Curve, DODO)
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The capital efficiency of AMM is not high because the liquidity of the constant product market-making curve is evenly distributed on the curve. For this reason, Curve mixed the constant product curve and the constant price curve to launch the stableswap curve. V2 based on this Introduced a market-making curve dynamically adjusted according to the price of the internal oracle machine, concentrating liquidity around the price of the oracle machine. Uniswap V3 proposes the concept of range pending orders, allowing users to provide liquidity within a selected price range, improving capital efficiency. DODO introduces external market makers to provide quotations through the PMM algorithm, and concentrates liquidity around the market price. DODO greatly improves capital efficiency through the PMM algorithm, and is currently the most capital-efficient DEX in the market. These three leading DEXs have adopted the method of centralized liquidity to improve capital efficiency, and we also believe that centralized liquidity and active market making will be the mainstream of iterative innovation of market-making algorithms in the future.
image description
Comparison of capital efficiency of the three major exchanges (data source: Coingecko, Defillamma)
There are also some newer exchanges that continue to innovate and improve market-making algorithms, such as Maverick AMM, which provides lower slippage; 3xcalibur’s Tri-AMM, which combines lending and trading; Trader Joe’s new AMM; Elasticswap Elastic AMM designed for stablecoins that dynamically adjust token supply, etc. Delphi also proposed the design of SLAMM some time ago to achieve cross-chain liquidity. There are also some exchanges that abandon the order book and pool model. For example, Contango neither uses the AMM mechanism nor the order book model, but realizes token exchange through the fixed-rate market.
Retail investors provide funds, agreements provide strategies
Ordinary users lack the ability to continuously track market information, and the market-making efficiency is low. If they cannot keep up with market changes, they may suffer greater losses. Although AMMs and others have greatly reduced the threshold for users to participate in market-making, market-making itself requires a higher professional level. Therefore, the agreement is based on the market-making mechanism of DEX and provides auxiliary market-making functions for ordinary users, which is established in terms of demand. The top DEXs have all improved the AMM mechanism and are developing in the direction of centralized liquidity and active market making, which further increases the difficulty for users to make markets. In the long-term market observation, we also found that there are agreements that have developed liquidity management functions based on DEX, and there are also agreements that provide services such as lending and lending for market-making funds. We believe that these agreements or DEXs that integrate these functions will develop into Decentralized asset management platform, this will be a development trend of DEX. For example, Aura Finance based on Balancer, Euler Finance's integration of Uniswap. Visor Finance, Method Finance, etc. provide active liquidity management based on Uniswap V3.
Multi-chain deployment
We do not discuss whether the future will be multi-chain, cross-chain or super public chain. From the perspective of market observation, we find that most DEXs have chosen to expand through multi-chain deployment. Although multi-chain deployment has additional development costs, the benefits are obvious, that is, a stable transaction experience and no need to worry about cross-chain security issues. L2 is popular among DEX deployments. The lower transaction fees make the trading experience of DEX very close to that of CEX, and market makers can also provide better quotations and market making.
New deployment chains of each DEX since March (incomplete statistics)
first level title
Will the real DeFi 2.0 come?
Since the market entered a bear market, some people have been bad-mouthing DeFi, using declining trading volume and TVL to prove that DeFi is dead. Has decentralized finance really failed? No, contrary to everyone’s perception, DeFi has not failed, but is running well. The declining transaction volume and TVL of DeFi are just like the falling market price of ETH. This is just a change in market conditions and does not affect the operation behind it.
Since the Luna incident, centralized financial entities, such as Celsius, 3AC, Voyager Digital, BlockFi, FTX, etc., have been hit by thunderstorms one after another. They are no different from traditional financial companies, leveraged, lack of transparency, and collapse in volatility , making its customers suffer heavy losses. And decentralized financial protocols, such as Uniswap, DODO, Curve, AAVE, Compund, MakerDAO, etc. are all working well.Despite the decline in transaction volume and TVL, the health of these DeFi protocols can be clearly seen compared to the opaque balance sheets of centralized financial entities,It is the code that determines life and death, not market conditions and asset prices that change with the environment
FTX will make people realize the true value of DeFi. Perhaps the DeFi narrative driven by trust and transparency will become the engine that truly drives the development of DeFi. The real DeFi 2.0 may come soon.
Reference
https://messari.io/article/dex-education-uniswap-optimistic-rollups-and-the-layer-2-dex-landscape
https://members.delphidigital.io/reports/uniswap-vs-curve-which-is-the-best-dex
https://www.paradigm.xyz/2021/06/uniswap-v3-the-universal-amm
https://messari.io/article/the-chronicles-of-uniswap-the-token-the-switch-and-the-wardrobe
https://www.nansen.ai/research/the-market-making-landscape-of-uniswap-v3
https://blog.dodoex.io/Five minutes to understand -pmm-algorithm behind dodo-a general liquidity framework and multiple use cases-39a49c222aff
https://resources.curve.fi/base-features/understanding-curve
https://docs.dodoex.io/chinese/dodo-xue-yuan/pmm-suan-fa-gai-lan/pmm-suan-fa-xi-jie
https://www.nansen.ai/research/the-market-making-landscape-of-uniswap-v3
https://uniswap.org/blog/uniswap-v3-dominance
https://dune.com/msilb7/Uniswap-v3-Pair-Deep-Dive
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about Us
"DODO Research Institute" led by the dean "Dr.DODO" led a group of DODO researchers to dive into the Web 3.0 world, doing reliable and in-depth research, aiming at decoding the encrypted world, outputting clear opinions, and discovering the future value of the encrypted world. "DODO" is a decentralized trading platform driven by the Proactive Market Maker (PMM) algorithm, which aims to provide efficient on-chain liquidity for Web3 assets, allowing everyone to issue and trade easily.
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