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What is Cross-chain Liquidity?
Liquidity typically refers to the speed and efficiency in which assets can be exchanged between buyers and sellers within a secondary market. The more liquid a market is, the easier it's to buy or sell an asset. Liquidity gives investors a number of insights into the health and wellness of financial markets, such as gauging overall risk, execution opportunities, or even assisting financial markets in price discovery, all of which factor into an investor's overall market strategy.
Liquidity is highly important within the crypto economy, allowing for the emergence of decentralized finance (DeFi) and corresponding financial technologies to be designed, developed, and implemented. The problem with siloed blockchain designs is that overall liquidity is fragmented and distributed across many different ecosystems, hindering the potential liquidity for each individual user of a particular blockchain. As of Q4 2022, there are an estimated 6,000+ different cryptocurrencies running largely on isolated blockchain networks.
Because of this problem, DeFi applications and related protocols suffer from profound competition within their isolated ecosystems for the little liquidity that exists within that network. As a result, this stunts protocol growth and overall adoption while also elevating the risk of cascading failures for the system as a whole (relating to liquidity shortages).
1inch
Launched in 2019, 1inch is an MLA that supports Ethereum, Ethereum rollups (Optimism and Arbitrum), and several EVM-compatible blockchains like Binance Chain, Polygon, Fantom, and Avalanche for a total of 10 different blockchains. In total, 1inch sources liquidity from ~200 sources in an attempt to provide the lowest cost trade possible. Aggregators like 1inch allow arbitrage traders to easily find pricing differences between multiple exchanges and exploit them while also reducing mispriced trading pairs across the ecosystem.
Currently, 1inch is the dominant aggregator on Ethereum mainnet with ~$5B in monthly volume, ~100,000 users per month, and nearly 85% of all Ethereum aggregator volume.
1inch Swap Engine
The 1inch Swap Engine is a decentralized trading and matching mechanism that connects DeFi users to centralized and decentralized liquidity via professional market makers. The 1inch Swap Engine introduces an entirely new type of decentralized order matching strategy based on the Dutch auction technique.
Resolvers are key to the 1inch swap process. Resolvers are professional market makers who pay the necessary gas fees to fulfill orders while benefiting from arbitrage trading. To become resolvers, people must stake 1INCH tokens and deposit an adequate amount of 1INCH into the "feebank" contract. Initially, resolvers will not be required to pay any fees; however, the 1inch DAO may impose resolver fees in the future.
Pathfinder
The 1inch Network utilizes its Pathfinder algorithm in order to route trades in the most efficient and cost-effective manner. Pathfinder is designed to:
- find the cheapest token swap price
- split a large transaction into several smaller sub-transactions (if necessary), and
- use separate order depths from various protocols
Due to Pathfinder’s dynamic order-filling mechanism, 1inch also helps reduce the likelihood a large transaction fails due to inadequate liquidity. Once a transaction is split across multiple liquidity sources, Pathfinder enables the ability to switch or cancel any liquidity source that is unfavorable compared to the rest. This means only the portions sourced from the most economically-favorable liquidity pools are used. All of these options can easily be toggled from the swap interface. Despite the 100+ liquidity sources, Uniswap and Curve remain the predominant protocols through which trades are routed.
Additional Features
In H2 2020, 1inch released a native AMM, enabling users to provide liquidity and earn passive liquidity mining rewards. In Q2 2021, the Limit Order Protocol (LOP) was released, supporting conditional limit and stop-loss orders with no fees. All three protocols are governed by the 1inch DAO using the network’s native 1INCH token.
As of H2 2022, 1inch has created a mechanism to safeguard users from front-running attempts and sandwich attacks. The tool, dubbed Rabbithole, features a special RPC API that enables users to send swap request transactions directly to validators, as opposed to having them queue at Ethereum's public mempool where MEV specialists could look to benefit. Typically, validators could reorder and reprioritize certain transactions over others in order to maximize their MEV-based profitability.
Finally, 1inch now supports multiple wallets/dapps like Metamask, Zerion, Wirex, Orange, and D’Cent.
