2020 is the age of decentralized finance (DeFi). Mostly domiciled in Ethereum, the total value locked (TVL) continues to rise. In Q1 2020, the TVL in Ethereum rose above $1 billion, a milestone at that time. Value under management by different DeFi protocols has since risen to over $10 billion as a direct relationship between TVL and the ETH price emerges.
DeFi and Trustless Swapping
DeFi is broad. In the early years, it was used to describe dApps that facilitated trustless lending. Here, coin holders could deposit their assets and earn interest. Meanwhile, loans could be accessed by depositing collateral. All this was done without an intermediary via smart contracts. It set a precedence.
Now, a big part of DeFi consists of decentralized exchanges or DEXes. A DEX is a cryptocurrency exchange without a centralized authority. Creators want to port the activities of leading centralized exchanges like Binance, Coinbase, and Bitstamp, to the blockchain.
Project creators adopted different approaches and architectures. In all these protocols, there are no KYC demands and documentation required when swapping coins and tokens.
Given the potential of DeFi, blockchains are calling on creators to launch open finance dApps within their ecosystems, considering how fragmented the web3 is. Ethereum, enjoying the first-mover advantage, is the most dominant.
Developments from Polkadot, a next-generation protocol aiming to connect supported blockchains creating one unified network, is encouraging. By connecting different blockchains, one of the biggest challenges faced by blockchains—scalability, is satisfactorily addressed. Besides, there is efficiency through cross-chain communication.
Within the interoperable blockchains is the Web3 Foundation-funded Polkadex mainnet set for launch in Q1 2021. From their GitHub page, creators say the dedicated blockchain is “an open-source, order book based DEX made using the Substrate Blockchain Framework providing users with centralized user experience.”
Advising their mission is the continued use of centralized versions of cryptocurrency exchanges despite the risks of losing funds. Centralized exchanges like Binance and Coinbase are custodial. This means, whenever a trader deposits funds, he/she relinquishes control to the exchange.
Earlier on, as BTC Peers reported, OKEX froze user funds for nearly a week, upsetting clients. Leading executives of the exchange were under police investigation in China.
Also, the fact that coins are under their custody makes them a target to hackers. Billions have been lost through the exploits of centralized exchanges. Additionally, centralized exchanges can censor transactions and have been accused of price manipulation.
Polkadex is addressing the trader onboarding problem caused by the complex nature of some DEX user interface, the absence of trading bot integration, the lack of high-frequency trading support, low liquidity, front running, and notably, support of tokens from multiple blockchains. That is, most DEXes don’t support cross-chain token transfer. Without an easy-to-use front end enabling easy navigations, beginner or even experienced traders prefer using centralized solutions.
Polkadex is, therefore, building on a decentralized network using Polkadot’s Substrate Blockchain Framework but is keen on addressing the interface problem by launching a trading experience with a “centralized feel.” They are targeting day traders who would ordinarily prefer centralized solutions because of convenience and the speed of order execution.
Substrate framework enables projects to build composable and interoperable blockchains without worrying about the technicality of block production and consensus. Also, it allows a modular way of building dApps. Combining these properties define a platform that fuses different technologies.
An Order Book and AMM Approach for Liquidity
The Polkadex trading platform runs on the Substrate framework. It is a dedicated DEX that is decentralized, interoperable with Ethereum and aims to be a Polkadot Parachain, merging Automated Market Maker (AMM) model--common in most DEXes, and the Order Book architecture used by centralized exchanges.
AMM strategies are only profitable whenever there is arbitrage because of price differences in other exchanges. In Polkadex, AMMs supplement Order Book-based DEXes by acting as on-chain market making bots as they connect directly with Polkadex’s trading engine. Orders are matched against not only the orderbook but also against the available AMM Pools allowing more guaranteed trades and less chance of price slippage common in AMM DEXes.
By combining a cloud architecture providing real-time trading experience with the interoperability aspect with Ethereum and other blockchains, Polkadex is responsive, and order execution is fast. Polkadex will connect Ethereum via Snowfork, a trustless bridge built by the Snowfork team. Once complete, users can lock assets in Ethereum (solving the custody problem) and trustlessly bridge liquidity to the DEX. Polkadex also aims to become a Parachain that will trustlessly bring liquidity from other blockchains through the Polkadot relay chain network.
Polkadex’s consensus algorithm is flexible and allows for a high throughput of up to 400 TPS under test conditions; enough to compete with any centralized option. Accordingly, the DEX supports high-frequency trading and users can enjoy high liquidity because of the incentives provided by the protocol.
In the early stages of DEXes, protocols struggled with liquidity. To resolve this concern and attract market makers and liquidity providers to its dual system, Polkadex is building a cloud architecture around its blockchain that supports standard bot protocols such as XCTT and Xchange. It will also make use of an intuitive and easy-to-use user interface for traders with high-frequency trading and who can also trustlessly integrate trading robots and earn a percentage of trading fees for bringing in liquidity. Market makers don’t pay network or trading fees but receive 0.1-0.3 percent of trading fees depending on where they complete the trade. In the order book, they earn 0.1%, and in the liquidity swap pool, they make 0.3%.
Polkadex also claims to have solved the front running problem plagued by decentralized exchanges in the past. By using a custom blockchain and an orderbook tailor-made to preserve the order of transactions as they come, it is impossible to front-run the trades in Polkadex. Feeless transactions also make it difficult to slip in orders at the last moment, a common tactic used by traders to take advantage of the publicly known incoming orders.
In the first version, there are two types of orders: Limit and Market, attracting a zero and 0.2 percent fee for market makers and takers, respectively. Aforementioned, half of the collected fees are collected by market makers while the rest is set aside for the Polkadex team for growing the network and improving the product. These improvements include margin trading, futures, options, and the whole nine yards.
Overall, Polkadex is a promising project that aims to achieve what many decentralized exchanges have failed in the past, leading the innovation which could possibly lead us to a world where DEXes will be the defacto norm to trade crypto.