The beginning of the end for AMM DEXes
DeFi rave has triggered the 2020 bull run for Crypto industry. Wherever you look, you see people trying to make AMM based DEXes. The success of Uniswap has probably made investors queuing up to invest in projects focused on liquidity mining and swap protocols. However, may we ask this question? Is this the final shape and form of Decentralized exchanges of the future?
To answer these questions, we need to go back two years into the crypto sphere — a world chocked by scalability issues with Ethereum. Smart contracts couldn’t scale to the level demanded by killer apps waiting to see the daylight to this very day. Blockchain evangelists and smart contract gurus foresaw a world run on intelligent contracts on the blockchain, but simply the “real estate” didn’t have the power to support their vision. People began writing off decentralized exchanges as merely a fad attempt to achieve something that didn’t catch popular imagination.
The answer was in plain sight. Rising gas fees and slow transactions curtailed the growth of an exciting vision. Network fees were prohibitive enough to have so many nodes competing for network space to uniquely verify transactions on the blockchain. Traders got fed up and left the scene, and with them disappeared the lifeline of any exchange — Liquidity. Pundits raved about how decentralized exchanges couldn’t scale with an on-chain orderbook.
The writing was on the wall. People started experimenting with off-chain order books to achieve speed. What is the point of decentralization if there were no transparency in order execution? The final nail in the coffin was the possibility of front running transactions that put retail traders at risk, at the mercy of investors with better computing power and larger stakes in PoS driven networks.
All of this resulted in Bonding Curves based and AMM pools or Constant Function Market Makers (CFMM) ruling the roost with Uniswap leading the industry trend. However, one can clearly see; the attempt to use AMM pool was a desperate attempt to save liquidity in DEX space. It wasn’t the popular demand; people thronged despite the deficiencies like price slippage and impermanent losses. It was something which everybody decided to settle for because Decentralized Exchanges didn’t have the technology to scale transactions to support a traditional orderbook.
We introduce Polkadex’s FSP (Fluid Switch Protocol). Polkadex is a hybrid DEX with an orderbook supported by an AMM pool. The first of its kind in the industry. Someone had to innovate. We are happy to do the dirty work. It may not be perfect, but we are sure that once implemented, it can solve the problem faced by DEXs paving the way for near-boundless liquidity and high guarantee of trades if supported by an efficient trading engine. The trading engine itself needs a separate look and it is a whole dedicated project in itself; hence it is covered in another medium article. Let’s stick to the core protocol here.
In FSP, incoming orders are matched against the orderbook first. Suppose the engine couldn’t match any order, instead of market-making against the orderbook; in that case, it is matched against the AMM pool, thereby giving additional liquidity for the orderbook and a possible arbitrage option created by the activity in the orderbook. Quickly said than done, but it is a complex protocol that switches between the orderbook and the liquidity pool based on the settings enabled by the trader. If he doesn’t want his orders matched against the AMM Pool, the same trade enters the orderbook as a market-making trade without affecting the user in any way.
In our opinion, this protocol will dramatically change the trading experience in a decentralized exchange. AMM Pools not only solve the liquidity problem, the pairing up with an orderbook creates frequent price swings in the liquidity pool, making arbitrage opportunity for an opportunistic trader, looking to earn from the swap pool. We intend to implement this switching seamlessly so that the focus will be on a fluid experience for the trader, when the trade happens in the background, fetching him the price he wanted without compromising experience.
To conclude, AMM DEXes needs to evolve and experimenting with innovations such as FSP will go a long way in achieving this goal. When you create equal opportunity for both market makers and traders, we could finally solve one of the longstanding problems faced by DEXes in the past — a DEX with fast orderbook and near-boundless liquidity to support it.