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dYdX: Exploring approaches to building liquidity on DEX’s

In blockchain’s ecosystem, with modifications(s) happening since its inception, the need for cryptocurrencies and stablecoins to get inter-changed for transaction purpose/s without much friction has come up recently. Separate industries experienced success individually with regard to transparency and accountability. To get economies of scale, the advancement of decentralized exchange trades (DEX) like dYdX have had become a necessity. This piece will dwell on unique approaches to making decentralized trade platforms turn liquefied. Some illustrations which get discussed here include “Atomic Bonded Cross-Chain Debt”, “Flash Loan”, “MakerDAO”, “Compound”, “dYdX”, etc. One of the core factors for developing liquefied DEXs is the dire urgency to make decentralized platforms and applications mainstream so that every single human being could benefit from the benefits of decentralized run platform/application(s).

You could look at smart contracts as the entry point of any decentralized exchanges. The initiation platform being, ethereum and application being, smart contracts. As the tipping point in the decentralized architecture was the financial industry (because of the financial breakdown of 2008-09), the intention in the early days was towards offering financial instruments, loans, options, etc. This research showcases that Atomic Bonded Cross-Chain Debt (ABCD), specifically hash-time-locked-contracts (HTLC) diminishes the gap which has been present making it not possible to economically scale DEX. One way (out of others) through which the liquidity on decentralized exchanges is supposed to be beneficial is the fact that you/coder/miner could write smart contracts on an electronic ledger(s). This characteristic will allow atomic swaps between two parties on distinct blockchains to transfer assets with each other in the future if required. The core idea behind the atomic bonds is flash swaps. Figure 1 represents the abstract functioning of atomic bond service. Every transaction has an appropriate signature, output amount, and lock time as well. If the individual/party has the secret reveals beforehand of timelock deadline, then the swap takes place. Otherwise, if the deadlock gets expired, the swap gets reverted and the locked values are sent back to the initial holders. Bond funding key and the exercise key can be said as the pivotal keys for the proposed model. The prior key is utilized to sell while the latter one is used for exercising the bond. In the end, you may look at this piece of research as a better option than other DeFi (decentralized finance) protocols, as ABCD could be utilized on diverse HTLC-compatible-blockchains without the requirement of Turing-based-complete-programming-language. The next piece of research talks about the “Flash Loan” and how it’s beneficial to the overall DeFi ecosystem.

Flash loan is a recent term that’s entered the decentralized ecosystem. The word in layman refers to a scenario where traders are allowed to request a non-collateral loan as long as the debt is repaid within the transaction period. There are two types of exchanges that are utilized while crypto assets are exchanged, namely “Limit Order Book (LOB)” and “Automated Market Maker (AMM)”. In the case of the LOB, a pair of buy and sell orders are matched for executing the exchange for distinct types of crypto-assets alongside a compatible cost agreed by the buyer and seller as well. While in AMM DEX, a cluster consisting of liquidity pools backed by liquidity providers is required to deposit distinct tokens for getting liquidity equilibrium. Figure 1 as showcased here is taken as an example to overcome while building the proposed model. In early 2020, a mishap happened where dYdX, Compound, bZx, and Uniswap experienced a hack. Figure 1 tries to indicate that due to large initial capital which eventually led to deepening of complications were reasons for such an incident to happen in the first place. The infographic placed below showcases the process of handling the issue (bZx hack). The process encompasses a 3 phase solution. Firstly, for filtering transactions defining the transaction pattern is a prerequisite. Secondly, four primitives are built by leveraging the transaction pattern(s) for understanding the semantics of the transaction(s). The primitives are:

  1. Exchange
  2. Lending and borrowing
  3. Margin trading
  4. Liquidation

Thirdly, the intent of each transaction is understood by combining recovered primitives.

workflow-of-thunder-strom image

The 3-phase solution is referred to as a Thunderstorm. The flash-loan identifier takes the assistance of transaction patterns for pinpointing and categorizing the primitives. A transaction pattern may encompass transaction event, invocation of the function, and chain of invocations of functions between smart contracts. A primitive classifier recovers the semantics f the transaction into four primitives (the ones mentioned above). Finally, advanced behavior classifier reveals the most-crucial information indicating the initial purpose from which intent could figure out. Figuring out the intent will assist in decoding a few intentions like arbitrage, avoiding swapping, etc. The next piece of research indicates some working about flash loan pools.

This particular piece focuses on Decentralized Finance lending protocols. If you’re someone who is technology geek then there’s a chance that you might know DeFi protocols operate on top of a layer-1 blockchain. Liquidity pool came into existence to overcome the issue(s) in crowdsourcing. As you may see from the infographic placed below, the flash loan pool initiates by providing a loan to the largest available liquidity pool which is also equivalent to the required capital. After that, borrowed funds are exchanged with the voting token. Then, via voting, the executive contract is replaced. Finally, the Ethereum collateral is absorbed to pay back the loan (it should be kept in mind that this is just an illustration).

flash-loan image

These three pieces of research mentioned above give you some idea about distinct ways liquidity can be built from scratch on decentralized exchanges. One thing for sure is that numerous approaches will come into the picture as this is turning out to be a necessity as compared to a desire. One factor for this change is the need to economically scale in every industry.

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Last modified on August 11th, 2023 at 2:11 pm