Cross-chain DeFi and UniswapX's Future

By Michael @ CryptoEQ | CryptoEQ | 14 Aug 2023

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One of the paramount concerns in the crypto space is the inherent inefficiencies and prohibitive costs when engaging in cross-chain operations, especially in lending, borrowing, and asset-swapping activities. A user keen on leveraging assets from Chain A to engage in farming on Chain B faces a costly and potentially dangerous path. From the initial collateralization on Chain A to finally uncollateralizing after the loan repayment, every step, including bridging and swapping, attracts fees. 

In the context of a blockchain, cross-chain refers to any technologies that actively enhance the connection and interoperability between independent blockchain networks to facilitate the transfer of digital assets, information, and value. Initially, numerous blockchain networks were designed as siloed, self-sufficient ecosystems with little need to have interconnectivity between ecosystems. Users would exist and manage digital assets solely within the system.

With the onset and expansion of DeFi and other decentralized applications, blockchain network utility has expanded substantially. Higher user demand for utilities has also resulted in demand for a presence in multiple ecosystems, leading to the necessity of cross-chain technologies in which users can interact across multiple blockchains. Cross-chain technology essentially creates messaging or communication rails between blockchains and can execute asset swaps or transfers, allowing users to exchange digital assets between blockchains.

Users leveraging this technology helps to remove the isolated and siloed nature of blockchains, resulting in the creation of an interconnected, diverse, distributed internet of blockchains. This can materialize in different ways depending on the needs of each individual user, but it typically comes from things, such as yield opportunities, across ecosystems, demand for governance of differing protocols, or taking advantage of varying consensus algorithm designs to reap the benefits of multiple ecosystems at once. 

As of 2023, cross-chain technologies operate mostly independently of the blockchain ecosystems themselves, meaning the platforms being connected are operating through separate systems from the interfaced networks. Alternatively, there are entire projects, such as Cosmos, Polkadot, Avalanche, and others, that are architected to create (somewhat) frictionless interoperability across sub-layers within their own ecosystem to avoid outside, third-party solutions. 

Asset Swaps

Existing Automated Market Makers (AMMs) proficiently handle swaps within individual chains. However, transitioning from one chain to another, for instance from Ethereum's ETH to Polygon's MATIC, introduces additional complexities. The multiple transactions required in this process inevitably compound fees, rendering it less attractive for users.

Last month, Uniswap Labs unveiled UniswapX, a novel, open-source, auction-based protocol designed to facilitate trading across Automated Market Makers (AMMs) and other liquidity sources. This new product is a liquidity aggregator designed to facilitate spot trades. Its design incorporates elements from both the CoW Protocol, which utilizes off-chain solvers, and 1inch Fusion, which employs a Dutch auction mechanism. However, UniswapX is not a mere replication of these systems. Instead, it functions as a request for quote (RFQ) system that taps into a variety of trading venues, both on-chain and off-chain. This development expands Uniswap's product suite beyond AMMs by incorporating an off-chain order routing protocol.

New Aspects of UniswapX

UniswapX operates with two primary participants: swappers and fillers. Swappers are entities that seek to trade and act as market takers. Fillers, on the other hand, are entities such as MEV searchers and on-chain market makers that assist swappers in achieving optimal execution for their trades.  Fillers in the UniswapX ecosystem can source liquidity from virtually any venue. They have the option to offer their own inventory at a price they deem fair, or they can procure it from venues such as Binance and Coinbase, among many others. The on-chain module, known as the "reactor," is responsible for accepting or rejecting execution on behalf of swappers. Before an order is finalized, swappers must specify certain parameters.

These parameters include the asset and quantity to trade, the absolute minimum output tokens they would accept, a function that gradually worsens pricing to ensure a fill, a time limit for the swap, and the usual approval to spend tokens. The inclusion of a decay function is a unique feature of UniswapX. This function, which gradually worsens pricing, allows swappers to attempt to secure the best price by setting pricing that is better than prevailing market pricing and have it slowly descend toward fair value.

UniswapX Source: Uniswap Labs

As UniswapX operates on an off-chain routing system, users are not required to pay gas when submitting their transactions. Instead, Fillers integrate gas costs into the execution price i.e. a swap still has a cost but is abstracted away. Users maintain the flexibility to alternate between using Uniswap's AMM offerings and the new off-chain routing protocol. UniswapX also plans to incorporate a cross-chain swap mechanism, simplifying the process and eliminating the need for users to bridge assets independently. 

This announcement follows Uniswap's disclosure last month of the development of Uniswap V4, an upgrade that enhances LP customization and functionality. UniswapX is currently in an opt-in beta mode, with no confirmed date for a full launch.

The launch of UniswapX is poised to address inefficiencies affecting Uniswap’s AMM model. While AMMs have been instrumental in providing liquidity to long-tail digital assets, they are inherently less efficient compared to alternatives like closed limit order books and can expose users to issues such as slippage and Miner Extractable Value (MEV) exploits.

By integrating an off-chain Dutch Auction process, UniswapX aims to mitigate some of these challenges and enhance the user experience. A larger portion of MEV can be redirected back to users instead of being retained by block builders and validators. Fillers can also employ strategies such as batching orders or sourcing DeFi-CeFi swaps to optimize gas prices and improve overall execution. This will create a more seamless trading experience for users and reduce reliance on automated routers.

The introduction of the cross-chain swap feature is a step towards mitigating risks associated with bridges, which are frequent targets of hacks. It reduces the need for passive liquidity to remain in bridges to facilitate swaps, offering users increased security. However, these improvements come at the expense of a more centralized off-chain ordering process.

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Michael @ CryptoEQ
Michael @ CryptoEQ

I am a Co-Founder and Lead Analyst at CryptoEQ. Gain the market insights you need to grow your cryptocurrency portfolio. Our team's supportive and interactive approach helps you refine your crypto investing and trading strategies.


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