An overview of the evolution of the CEX to DEX process (good in-depth article)

An overview of the evolution of the CEX to DEX process (good in-depth article)

Written by: Footprint analyst Vincy (vincy@footprint.network)

Date: November 2021

Data source: Footprint DEX Dashboard

According to coinmarketcap, there are currently 433 cryptocurrency exchanges. With the development of the crypto market, from traditional financial exchanges, centralized exchanges to decentralized exchanges, the evolution of the entire process symbolize that cryptocurrency trading has created a new concept, and decentralized blockchain technology has become Up the trend.

Let us review together, what are the evolutions between centralized exchanges and decentralized exchanges?

About CEX and DEX

CEX (Centralized Exchange) refers to a centralized trading platform, represented by exchanges such as Coinbase, BSC, and OKCoin, which gather a large number of users and transactions and provide sufficient asset liquidity. Its business is mainly carried out in the trading platform, providing users with an accounting system, real-name authentication, fund recharging, transaction matching, asset clearing, and exchange services.

DEX (Decentralized Exchange) is a blockchain-based decentralized trading platform. It does not store user funds and personal data on the server but serves as an infrastructure to match buyers and sellers who wish to buy and sell digital assets. , Represented by exchanges such as Uniswap v3, PancakeSwap, and Sushiswap .

The biggest difference between CEX and DEX is:

  • CEX trading assets are stored in the exchange’s wallet, while DEX trading assets are stored in the user’s wallet;

  • CEX needs to go through KYC, and exchanges can obtain user-related information. Most DEXs do not require KYC, nor do they need to register and log in. They are exchanges that provide transaction exchange services on the go.

Problems solved by CEX and DEX

CEX and DEX play different roles, and they are constantly improving the development of the cryptocurrency trading ecosystem. It is undoubtedly optimistic that exchanges have huge profit margins, and more exchanges will join.

In its role, CEX plays the role of traditional exchanges, banks, fund companies, etc., helping buyers and sellers to hold funds, conduct transactions, provide security and monitoring, and DEX is also the largest project category in Defi projects. Anonymity is supported in transactions, without the need for third-party project parties to intervene in funds, giving most investors control over private keys, and enhancing the credibility of the transaction process.

But since Compound introduced liquidity last summer, the Defi ecosystem has grown, attracting more investors and projects. With the huge transaction liquidity, DEX has gradually threatened the monopoly of CEX, from CEX to DEX. They solve different problems at various levels:

  • Security of funds. Users are worried about their funds being stolen or worry about the exchange running away, lack of trust in the transaction process, the existence of DEX, to provide users with some protection, security has been greatly improved, each user has an independent transaction Address, but need to strengthen the management of the key, once the key is lost, it cannot be retrieved;

  • Business compliance. CEX is supervised by the government, and the regulations governing the blockchain ecology will vary from country to country. As a decentralized innovation ecology, DEX has not yet been effectively monitored. Everyone can participate in the construction and operation of the ecology. It is an issue that the project parties pay more attention to;

  • Transaction efficiency. Most DEX projects are traded on the Ethereum network, causing congestion problems, making the entire transaction and settlement process inefficient, while CEX is highly centralized and has some advantages inefficiency. After the wallet is recharged to the exchange, it will automatically transfer to the total address of the exchange, wait for the user to issue an instruction, and the exchange will match the transaction. Similar to the traditional financial P2P model, the CEX exchange acts as an intermediary for matching.

The difference between CEX and DEX fees

SEX

  • Deposit coins, users recharge to the exchange, there is no handling fee at present;

  • Transaction, transaction costs are borne by the user and directly deducted from the user’s corresponding currency;

  • Withdrawal, the withdrawal will directly charge the user a certain handling fee.

DEX:

DEX, there are also deposits (there is no separate deposit, use DEX to indicate authorization), transactions (users bear handling fees and miners’ fees) and withdrawals (no need to operate the withdrawal action), in addition, DEX represents the transaction fee for the project In terms of share and capital utilization, different projects are used to further explain the composition of DEX’s liquidity and transaction fees.

Provide liquidity

Increase transaction fee-sharing/fund utilization

  • Increase or decrease fees based on market prices and transaction conditions: Kyber

  • According to personal risk preference, fees are graded: Uniswap v3

  • The price range that provides liquidity: Uniswap v3

  • Introduce the market price, focus on the market middle price: DODO

Reduce impermanence loss (occurs at the time of exit)

  • Idle funds in the fund pool are lent to the loan agreement, and the proceeds are returned to the user: Balancer

  • Customize the proportion of currencies in the liquidity pool: Balancer

  • Impermanent loss insurance: Bancor

trade

Reduce transaction fees

  • Reduce the number of transactions

  • Small pool “merge” big pool: Balancer

  • “Index Fund”: Balancer v2

  • DEX aggregation: 1inch

Reduce slippage

  • Realize the ultra-low slippage exchange of different types of assets through the synthetic asset bridge: Curve

  • DEX aggregation: 1inch

  • Zero slippage trading: 1inch OTC; Match Gasless Trading

Reduce gas fees

  • 1inch: Gas token Chi, transaction costs can be reduced by up to 42%

Earlier, some users believed that DEX cryptocurrency transactions could not replace CEX, and the sophisticated AMM market maker mechanism could not replace the mature CEX model, and there were problems such as Ethereum network congestion and high gas fees. Can the problems of DEX not be solved?

Next, we mainly analyze from the DEX business classification.

Look at its development history from DEX business classification

An overview of the evolution of the CEX to DEX process (good in-depth article)

Footprint Analytics: Total monthly volume of DeFi& DEX agreement

An overview of the evolution of the CEX to DEX process (good in-depth article)

Footprint Analytics: TVL trend of DeFi&DEX agreement

The continuous improvement of the underlying technology and the vigorous development of applications on the Ethereum public chain have driven the rise of Defi. According to Footprint Analytics, there are currently more than 1026 Defi projects, of which 254 are DEX projects and 772 are other types of projects. ; Defi total lock-up (or TVL) reached 280.7 billion US dollars, of which DEX accounted for more than 86 billion US dollars, DEX TVL accounted for 33% of Defi total TVL, DEX played a pillar role in the Defi ecosystem.

An overview of the evolution of the CEX to DEX process (good in-depth article)

Footprint Analytics: Top 20 DEX Protocol TVL’s Market Share

DEX based on liquidity pool 

Whether in the traditional financial industry or the cryptocurrency market, the liquidity of funds is one of the important factors. Without liquidity, it is difficult to leverage the vigorous development of the market. The liquidity pool is essentially a reserve of two or more tokens. These tokens exist in the smart contract of the DEX and are available for users to trade at any time. 

DEX trading mode

From CEX to DEX, trading has always been one of the daily activities of users, and CEX has become the most mainstream cryptocurrency trading platform in the market before the rise of DEX, so the core concept of DEX at the beginning of development replicates the mature CEX model, Choose the mode of the order book and matching in the market-making mechanism. However, due to factors such as gas fee, block generation sequence, and time, the on-chain is less flexible than centralized servers, etc., and there is a big gap between the market-making experience and CEX.

Later, DEX automatically completed the exchange of traders and assets in the liquidity pool through automatic market makers (AMM) to realize currency transactions. AMM broke the restrictions of the order book and matching, and successfully released DEX from the CEX model.

AMM, the automated market maker, uses the constant product formula: x * y = k

An overview of the evolution of the CEX to DEX process (good in-depth article)

Footprint Analytics: Top DEX protocol token transaction volume

At present, the top DEX projects in terms of trading volume adopt the AMM trading model. For example, the top projects Curve, Uniswap, Sushiswap, and Balancer, the current token trading volume has reached the level of 1 billion US dollars, which is also the emergence of AMM Help DEX break CEX’s monopoly on the cryptocurrency trading market and make open and free on-chain transactions a reality without permission.

AMM is not perfect. In the process of adopting the transaction model in various projects, it was discovered that its defects were slowly leaked:

  • Functional layer restrictions, AMM DEX quotations, and transactions need to be completed according to the real-time status of the exchange pool;

  • On-chain transaction issues, the entire process from market-making to the transaction needs to be completed on-chain, affected by network congestion, and the need to pay expensive gas costs;

  • The AMM model has the problem of high slippage. The liquidity of AMM DEX depends on the exchange pool. When the scale of a single transaction is too large compared to the exchange pool, slippage loss will occur.

The defects of the AMM model, there are corresponding DEX head platforms that continue to improve the AMM mechanism, such as Curve occupies the leading position in the DeFi project, the biggest reason is that it has been positioned as a decentralized design specifically for stable coins since its inception. Chemical exchanges have also made breakthroughs in solving the problems of high slippage and high gas costs in the AMM model. And Bancor has been updated from V1 to V2, so that the model can mortgage unilateral assets and earn profits under the condition of impermanent loss protection.

The Uniswap version is iterative, from V2 to V1 expanding the trading pair, supporting any ERC-20 token, LP Token can automatically compound interest, and continue to flow. This is the most innovative point of Uniswap V2; to the concentrated liquidity of Uniswap V3, its First, LPs can control the price range that they want to provide liquidity and improve capital utilization; second, LPs can choose the expense ratio (0.05%, 0.30%, 1.00%) according to their needs. It shows that Uniswap V3 is very good at calculating in the AMM model.

In addition, the AMM arbitrage method is to preemptively trade, through higher Gas fees to execute the transaction before another trader, which affects the order of transactions and thus the result of the transaction.

For example, the preemptive transaction process in the ETH /INJ market is as follows:

  • User A wants to buy 1 ETH INJ at the price of x, and the Gas price is y

  • User B sees the transaction on the blockchain

  • User B pays the Gas price z, where z> y, and purchases 100 INJ at the price x

  • The transaction of user A is passed, but the user can only purchase 90 INJ for 1 ETH

  • A user’s transaction causes the asset price to rise

  • User B sells 100 INJ and earns ETH

PMM, namely Proactive Market Maker (Proactive Market Maker)

An overview of the evolution of the CEX to DEX process (good in-depth article)

Footprint Analytics: DODO TVL trends

According to Footprint Analytics, in early June, the TVL of the DEX project DODO exceeded US$49 million to over US$200 million within a few days, an increase of more than 340%. It adopted its own original PMM algorithm to provide users Provide a lower slippage than the AMM agreement and the risk exposure of a single asset to reduce gratuitous losses. PMM means active market maker, and it is also the main difference between DODO and other DEX.

The core of PMM is to guide prices by introducing preview machines, imitating the behavior of other types of market makers, and obtaining the current market price of a certain token by introducing price parameters, so that a large number of market makers can be gathered in Near the mid-market price, a relatively flat price curve can be achieved and more sufficient liquidity can be provided.

This also means that PMM has a higher capital utilization rate and lower slippage, and the price offered will be more favorable.

DMM, that is, automated dynamic market maker (Dynamic Market Maker)

DMM reduces infrequent losses and improves the profits of liquidity providers through dynamic fees. It has to be said that a typical DEX project Kyber, which follows the problem of low capital efficiency and free loss of the AMM model, monitors the transaction volume on the chain. And adjust the price accordingly:

  • When the market is normal, DMM will operate like other AMMs;

  • When the transaction volume is higher than usual, DMM will raise the fee;

  • When the transaction volume is lower than usual, DMM will lower its fees.

This is similar to the profit maximization strategy of professional market makers, which dynamically adjust market makers.

DEX aggregator

After the advent of the liquidity market-making mechanism, a variety of applications such as liquidity aggregators have been launched successively, expanding the business scope of the entire DeFi ecosystem. What is an aggregator? As the name implies, it can integrate liquidity and intelligently transfer orders to enable users to perform transactions optimally, reducing transaction costs, transaction times and GAS fees.

In Swap, the quotation is lower than the final transaction price, which actually causes a positive slippage. For example, when a user buys ETH, the ETH price is $1,000. When the network congestion leads to the final settlement, the market price of ETH has fallen to $995, but the user Still need to pay $1,000 to buy an ETH, indicating that the user has paid an extra $5 to buy ETH, which is a positive slippage.

At present, there are many representative projects of DEX aggregator emerging, including 1inch, Matcha and Paraswap, mainly analyzing the 1inch aggregator project.

An overview of the evolution of the CEX to DEX process (good in-depth article)

1inch: Multiple liquidity agreements transfer order transactions

1inch is a DEX aggregation service provider that automatically matches the optimal transaction path for users and executes the exchange with one click.

The DEX aggregator uses advanced algorithms to find the most effective exchange path by searching more than a variety of liquidity agreements, so that traders can obtain the most effective transaction prices.

According to Footprint Analytics, the trend of 1inch’s TVL and transaction volume is relatively stable. In the top DEX protocol transaction rankings, 1inch v2’s transaction volume ranks 9th, indicating that the aggregator is also constantly updated to provide better users. Transactions.

An overview of the evolution of the CEX to DEX process (good in-depth article)

Footprint Analytics: 1inch TVL trend

An overview of the evolution of the CEX to DEX process (good in-depth article)

Footprint Analytics: 1inch transaction status

As mentioned above, there are problems such as low efficiency and difficulty in finding the best exchange rate transaction path. The DEX aggregator can find the best token exchange rate for users in the shortest time. Through a variety of strategies, such as the connection source 122 protocol, the maximum Profits, minimum gas fees, etc., users can receive an accurate quotation amount, allowing users to complete the best transaction at the best price, avoiding losses and risks caused by price fluctuations.

Summarize

With so many DEX projects, how should we select suitable projects? There are the following evaluation suggestions:

  • There is no doubt that choosing Curve with stablecoins can realize the ultra-low slippage exchange of different types of assets;
  • If you are good at calculating the cost ratio, you can choose Uniswap v3;

  • Bancor can be chosen for impermanent loss insurance;

  • Introduce the market price, focus on the market middle price, choose DODO;

  • In swap, reduce transaction fees and reduce the number of times. If you want a better experience, you can choose DEX aggregation 1inch and so on.

The blockchain ecology is constantly updating and iterating, and various projects are constantly breaking through and innovating. From CEX to DEX, they solve network congestion, high gas fees, capital utilization and other problems at all levels, and provide them to projects and Users bring better experience and more premiums. I believe that in the near future, more projects will bring new inspiration to the DEX track and bring greater value to the crypto market.

For more data dynamics and content of the blockchain ecology, click to read the original text to view more project dashboards and analysis content.

The above content is only a personal opinion, for reference and communication only, and does not constitute investment advice. If there is an obvious understanding or data error, feedback is welcome.

The data used in this article comes from Footprint Analytics, which provides cross-chain, cross-platform analysis data and multi-angle analysis Dashboard. If you are interested, you can click on the relevant links to explore.

Posted by:CoinYuppie,Reprinted with attribution to:https://coinyuppie.com/an-overview-of-the-evolution-of-the-cex-to-dex-process-good-in-depth-article/
Coinyuppie is an open information publishing platform, all information provided is not related to the views and positions of coinyuppie, and does not constitute any investment and financial advice. Users are expected to carefully screen and prevent risks.

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