Will the CeFi crisis of trust start the real DeFi 2.0? An overview of DEX development trends

Original title: "CeFi trust crisis will start the real DeFi 2.0? —DEX Development Trend Inventory"

Original source: DODO Research Institute

Why DeFi is the general trend

CeFi trust crisis

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As the second largest encryption ecosystem in the industry after Binance, FTX suffered a run in a short period of time, and a sudden thunderstorm shocked the entire encryption currency 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 ecology supported by the centralized trading platform?

The thunder of FTX is by no means the failure of Crypto, it just reflects the failure of the centralized financial system Vulnerability, 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 What bizarre operations they can do in an environment that lacks supervision and relies on self-discipline.

The second largest trading platform in the cryptocurrency world, with compliance, security and good reputation as FTX’s brand image came crashing down in a week, and nothing better demonstrates the fundamental problem with centralization—you can’t verify what’s really going on with a centralized entity, other than choose to believe it.

Crypto provides a decentralized, free, open, censorship-resistant environment and infrastructure, and many centralized entities choose to exploit 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.

Trust cost and optimism bias

FTX is not the first centralized trading platform to take a hit, nor will it be the last. In the short course of Crypto’s development, there have been thunderstorms on centralized trading platforms 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?

Because of the cost of trust and the existence of optimism bias, the public will continue to look for the next one they believe in CEX. 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 initial design purpose of the blockchain is to solve the trust problem, how to provide Consensus is reached in the case of endorsement. 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. Let each participant clearly know that trust has a cost, and the fees paid by users can support the operation of the entire system. contract, the public chain is attacked, etc.) is extremely difficult, and the system is robust.

However, in managed CEX, the distribution of trust costs is extremely uneven, and only when When CEX is thundering, users will really bear the cost of trust. In fact, every centralized trading platform has a trust cost due to its opacity and unverifiability, but the trust cost will not appear during its normal operation. The centralized trading platform does not need to pay the trust cost in advance, because as long as the user chooses to believe, the cost to maintain the trust is very small, but the loss caused by the dishonesty is huge, and the loss is after the event. Immediately experience the cost of trust you are bearing.

People generally have the phenomenon of optimism bias, that is, individuals tend to think that they are more likely to experience good While others are more likely to experience bad things, everyone generally thinks that they are the luckier one, and do not want to believe that the trading platform they choose may be thunderstorms.

Because of the trust cost of CEX having this structure and the widespread optimism bias, the public After experiencing thunderstorms on the trading platform again and again, I will still make my own judgment and choose the next centralized trading platform that I think is no problem.

DeFi is the only solution to the trust problem

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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 over financial markets.

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 the trust problem. Let the public chain carry financial activities, use cryptography to ensure the security and transparency of the ledger, transfer the right of choice to users, and keep 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 bull and bear, the centralized trading platform occupied an absolute dominant position, people In the face of a huge panic, the funds can only be transferred to the cold wallet. When the popularity of transactions increases, the only option is to choose a centralized trading platform. And this cycle should be broken by DeFi.

In the last round of bull market, the experience of DAPP has been improved unprecedentedly, and the decentralized trading platform The trading experience of Uniswap is not much different from that of the centralized trading platform. In terms of the trading depth of mainstream currencies, the trading depth of Uniswap's WETH/USDC pool even exceeds that of the centralized trading platform.

The most important thing is that DeFi The cost of trust is lower. Although the existence of network fees makes the friction cost rise, the trust problem is solved by the public chain. The trust cost of the whole system is completely explicit. The uncustodial service makes it almost impossible to run in a short time. The whole system Uncertainty will decrease accordingly.

DeFi Summer, that is, DeFi 1.0, the market is full of various high APY projects, the entire The explosive state 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, which is uncustodial, transparent on the chain, and resolves trust , this will be a new narrative:

CeFi’s crisis of trust will become the real starting point of DeFi 2.0 .

The paradigm shift brought about by DeFi, following the code is the law, which brings many users Problems on the threshold, MEV, various security problems, the solutions to these problems will be continuously optimized, but the problems brought about by the new paradigm will continue, and the development of DeFi will be a long way.

Control your own assets, don't be an ostrich

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In economics, the ostrich effect refers to the phenomenon that investors selectively ignore negative information.

The FTX thunderstorm deeply impacted everyone. After experiencing the FTX thunderstorm, Don't ignore the risks of centralized entities, start from 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 using DEX to trade Tokens and using lending protocols to lend assets, you will get rid of your dependence on centralized trading platforms.

After experiencing the FTX thunderstorm, ordinary users should also learn to use at least one DEX to do it Transactions and news are flying all over the sky. Instead of transferring back and forth in an opaque centralized trading platform, it is better to use DEX to solve transaction problems once and for all. At the same time, you will find that in the world of DeFi, there is not only DEX.

We believe that the thunder of the second largest encryption trading platform will profoundly affect the market and Users will be profoundly reminded that not your private key is not your money.

Current status and development trend of DEX

Status of DEX

< p>I think that in ten to twenty years time, decentralized exchanges will be bigger than centralized ones. ——Founder of Binance, 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 legal currency deposits and withdrawals. The corresponding DEX or protocol provides the function. 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 Chart function, front-end built-in K-line tool. 1inch, 0x Protocol, DODO, Tokenlon, Paraswap, etc. have 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 currently has certain user education problems, such as private key management, wallet interaction, There is still a certain difference between CEX and CEX in habit. And the liquidity of DEX is still insufficient compared to CEX, but these will no longer be a problem as time goes by. 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.

In the past thirty days, some mainstream DeFi protocols, the number of users and The number of chain transactions has 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, and at the same time indirectly stimulated on-chain transactions.

As of November 16 2PM UTC+8, the 24h trading volume of Uniswap V3 surpassed OKX, ranking third in CEX, second only to Binance and Coinbase.

Development trend of DEX

We have been tracking the product dynamics and market dynamics of DEX for a long time, through DEX weekly The form of brief is open 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.

Fluidity on routing aggregation chain

The routing algorithm will become more and more efficient, the degree of aggregation of liquidity on the chain is and will continue to increase, and transactions on the chain will integrate all liquidity, The potential of on-chain liquidity far exceeds that of centralized trading platforms, which will improve the transaction efficiency of the entire system.

The biggest advantage of on-chain liquidity is that it can aggregate with each other, which is also the natural characteristic 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 principle is the same. When a user makes a transaction request, the routing algorithm will calculate the most Optimal trading path, by interacting with multiple liquidity pools to achieve better trading prices and lower slippage.

Since the liquidity on the chain is decentralized, even in a DEX, a transaction There may also be multiple related liquidity pools. Therefore, in the process of pursuing the optimal transaction price and the lowest slippage, DEX needs to aggregate other sources of liquidity to provide better transaction prices. 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.

In the long-term impact on the DEX market In our observations, 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, making 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 the aggregator, 1inch, Matcha, 0x Protocol is the aggregation of the head 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. integrated 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 RoketX, which aggregates centralized trading platforms.

The number of DEXs using the aggregation function is increasing. For example, Sushiswap launched Trident at the beginning of the year to access the aggregator And aggregate the liquidity of DEX, and then upgrade the routing algorithm; Jupiter aggregates the liquidity on the entire Solana; Canoe Finance integrates the routing aggregation algorithm of DODO to realize the aggregation function.

The integration of wallets and DAPPs on DEX liquidity is also increasing, and routing aggregation is essentially The decentralized liquidity on the chain is integrated, and the ideal situation will be that no matter what protocol is invoked on the front end, it will interact with the liquidity on the entire chain.

Introducing professional market makers and providing RFQ functions

A large part of the liquidity of CEX is provided by professional market makers, while DEX asks market makers for prices through the RFQ function, allowing Professional market makers become counterparties, providing 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 the centralized trading platform, 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 cost issue. If the order book is the best choice under the frictionless situation, 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 resistant to MEV attacks. Less or no gas payment is because the market maker pays the gas fee for the user, and does not reduce the overall transaction cost (because there is an inevitable overhead for interacting with the blockchain). Combining functions such as limit orders can provide users with a good trading experience. Since quotations and matching are completed off-chain, it is resistant to MEV attacks and reduces the uncertainty of swap on the chain.

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 a trading platform 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.

Constantly improve the market-making algorithm and market-making experience to pursue higher capital efficiency

Liquidity pool is a native chain solution, here 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 Efficiency

The introduction of AMM is a subversive innovation, everyone can make the market to provide liquidity, which improves the liquidity of the chain Potential cap, but AMMs have capital efficiency issues. 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. The core market-making algorithm determines the capital efficiency of DEX and the accompanying core trading experience. The iteration of the algorithm will continue. How to cover higher trading volume with less TVL will be an eternal topic for DEX exploration.

We have demonstrated the aggregation of liquidity on the chain and the liquidity in the market Under the trend of integration, the competition of DEX is direct and fierce, who can make the market more efficiently, and who can occupy a larger market share in the aggregation.

Centralized liquidity is Main Trend

AMM is not capital efficient 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. A market-making curve that concentrates liquidity around the oracle price.

Uniswap V3 proposes the concept of range pending orders, users can 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 all 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.

There are some newer 3xcalibur’s Tri-AMM combines lending and trading; Trader Joe’s new AMM; Elasticswap dynamically adjusts Token Supply Stablecoin Design Elastic AMM etc. Delphi also proposed the design of SLAMM some time ago to achieve cross-chain liquidity. There are also some trading platforms 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 AMM etc. have greatly lowered the threshold for users to participate in market making, but market making itself requires a high professional level. Therefore, based on the market-making mechanism of DEX, the agreement 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 some agreements have developed liquidity management functions based on DEX, and there are also agreements to provide loans for market-making funds, etc. We believe that these protocols or the DEX that integrates these functions will develop into a decentralized asset management platform, which 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

The competition on the public chain track is fierce. Although it is impossible to predict who will be the next Ethereum killer, DEX is being widely deployed and bet in order to achieve a greater degree expansion.

We don’t discuss whether the future will be multi-chain or cross-chain or super public chain. From the perspective of market observation, we found 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.

Will the real DeFi 2.0 come?

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, successive thunderstorms have been centralized financial entities, such as Celsius , 3AC, Voyager Digital, BlockFi, FTX, etc., they are no different from traditional financial companies, leveraged, lack of transparency, collapsed in volatility, and caused their customers to 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, compared to the opaque balance sheets of centralized financial entities , the operating status of these DeFi protocols can be clearly seen, and it is the code that determines life and death, not market conditions and asset prices that change with the environment. This just proves the superiority of DeFi, which is to provide an open, transparent and stable financial system for all participants.

FTX will make people realize the true value of DeFi, perhaps driven by trust and transparency The real DeFi narrative will become the engine that really drives the development of DeFi, and the real DeFi 2.0 may come soon.

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