The decentralized finance (DeFi) industry continues to reach unprecedented highs, with daily volume of transactions increasing on a regular basis. Unfortunately, in spite of the billions of funds currently being crossed back and forth, decentralized exchanges (DEXs) are filled with apparent and invisible costs that are a hindrance to market activity.
Consequently, the future of DeFi requires eliminating the high transaction costs and limited functionality often associated with traditional DEXs. Among them is slippage, the price difference between a cryptocurrency’s quote price and the trader’s actual paid price. This is in addition to limited liquidity, expensive gas costs, lack of control over execution price, and the risk of front-running, which is done by malicious traders placing a transaction ahead of a trader based on insider knowledge of their future trade. Solving these concerns means DeFi could achieve parity to centralized exchanges (CEX), while removing the need for middlemen.
For example, with regards to the order book functionality: centralized trading platforms typically sort limit orders by price, from the highest to the lowest. The order book of BTC/USD trades, to name an example pair, will contain all the purchase and sale orders that have been placed on the exchange at different (limit) prices.
At the top of the book, users can find the highest bid for BTC, and at the bottom, the lowest ask prices; the middle of the book, where bids are closer to asks, will help determine the point at which a new market order will be executed. Slippage occurs when a market trade is larger than the amount available at the first level of the order book, or also when the bid and ask prices change before the exchange can execute the market order. Slippage essentially means the trader pays more than expected for their order.
Currently, all DEXs on DeFi only support market or spot orders, meaning when a trader swaps, they are at the mercy of market conditions, a factor completely out of their control. In DeFi, this concern is increasingly prominent given the sometimes extreme volatility in the market.
To mitigate the impact of volatility, investors using centralized exchanges will often execute a limit order, where the required target price is pre-set as a condition for the trade. The larger the size, the greater the benefit of a limit order compared to a market order. Unfortunately, executing a trade of this type was previously not possible in a decentralized environment.
From human-driven to automated
DeFi platforms currently offer primarily market order functionality, without order books or limit order capability. Much to users’ surprise, “limit orders” offered by DeFi platforms are simply executed as delayed market orders, with all the associated costs and implied inefficiency. Whereas limit orders are the pillar of centralized exchanges, attracting significant human work to enter and execute them, they have been missing in decentralized exchanges.
The appeal of DeFi is to democratize market-making on the blockchain so that any user can provide their own liquidity and let anyone else submit a buy or sell order through automated smart contract-operated trading networks, which ensure any trader can participate fairly. However, letting traders specify their target price while avoiding slippage and other costs has been a challenge in DeFi until now.
Try as they might, DeFi platforms have typically only provided basic automation through smart contracts. DEXs line up buy and sell orders, match and resolve trades, only failing to deliver on the experience users have come to expect on a centralized exchange when it comes to liquidity. Therefore, if DeFi ever wants to rise as the alternative to traditional finance, a solution that involves instantaneous order books is needed.
Removing DeFi trading costs for good
By using a DeFi order book, which is fully automated and decentralized, traders can finally avoid the costs of…
Read More: cointelegraph.com