In this article, we present two interconnected narratives: the first narrative outlines the technological evolution of DeFi liquidity, while the second narrative emphasizes the transformative impact of on-chain barter from an economic historical perspective. In summary, our goal is to affirm that a profound DeFi revolution is on the horizon, with just a little more patience required. Those visionary builders who persevere will ultimately reap the rewards of the market.
We closely track the development of the DEX market to illustrate that the emergence of on-chain barter trading is not a coincidence, but a true game-changer. It represents an important chapter in the history of Web3 builders. Achieving its functionality requires significant innovation and improvement, not only within DEXs but also at the underlying infrastructure layer.
If on-chain barter becomes a significant milestone in history, we believe that all relevant efforts and contributions should be appropriately commemorated.
Have we lost control of the pace of the crypto industry?
Since January 2023, Bitcoin has dropped to its lowest point and rebounded to new highs, driven by ETF approvals and expectations of new quantitative easing. However, the prices of most altcoins have not shown the same upward momentum as before. Some investors mock true innovation and view the crypto world as a realm of crime. At various conferences, industry insiders even refer to the entire industry as resembling a casino. Many crypto enthusiasts revel in the excitement of PvP (player versus player). While memecoins were popular in the early stages of a bull market, value tokens were overlooked by the market.
Seasoned players feel that this time is indeed different. Some developers are confused and question whether cryptocurrencies can really change the real world. Since last year, many have shifted their focus to artificial intelligence, while others remain hesitant.
Why is the cryptocurrency market different this time?
We cannot ignore the influence of venture capital, team greed, misaligned incentives, unethical behavior, and short-term thinking. The market has long been in a dark forest. Besides the code, there are not many rules to regulate participants. These issues have existed for a long time and are not sufficient to explain the lackluster performance of this bull market. Therefore, we propose an additional reason: the self-inflation within the crypto market is no longer sufficient to provide the necessary liquidity for our crypto ecosystem.
Therefore, we propose an additional reason: the self-inflation within the crypto market is no longer sufficient to provide the necessary liquidity for our crypto ecosystem. Please refer to the following chart:
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Source:
The chart shows the activity of various crypto equivalents. If we look at the trading volume ratio, we can see that for the past year or two, the majority of trades have been in USD stablecoins. If the market value of USD stablecoins cannot expand, liquidity pools will be drained as new coins are continuously issued.
In the past, due to the bull market of Bitcoin and Ethereum, tokens could become the liquidity of others, so most altcoins rarely lacked liquidity. But now, most trading pairs are pegged to USD stablecoins. Even the explosive growth in the value of Bitcoin or Ethereum is useless as the status of stablecoins makes it difficult for BTC and ETH to inject liquidity into other tokens.
The pricing power of cryptocurrencies falls into the hands of Wall Street
All USD-pegged stablecoins and other compliant financial instruments are bait. Cryptocurrencies follow Wall Street’s clock.
In October 2014, Tether began offering a stable digital currency that bridges the gap between cryptocurrencies and fiat currencies, providing the stability of traditional currencies and the flexibility of digital currencies. Now it has become the third-largest token by market capitalization. Additionally, USDT has the most trading pairs in the index, 10 times that of Ethereum or wBTC.
In September 2018, Circle partnered with Coinbase to launch USD Coin (USDC) under the Centre Consortium. It is pegged to the US dollar, with each USDC token linked to a 1:1 ratio to a US dollar reserve. As an ERC-20 token, USDC enables seamless transactions and integration with various decentralized applications.
On December 10, 2017, the Chicago Board Options Exchange (CBOE) became the first to launch Bitcoin futures, which can impact the spot price of Bitcoin even if settled in USD, especially now that Bitcoin’s open interest accounts for 28% of the global market.
Wall Street not only influences the crypto market physically but also psychologically. Do you still remember when we started paying attention to the attitudes of the Federal Reserve, Grayscale’s trust unwinding, the “dot plot” of the FOMC, and the cash flows of BTC-ETF? All this information psychologically affects our behavior. Stablecoins are the bait thrown by the US, and since we accepted stablecoins pegged to the US dollar as a means of providing liquidity, they have gained consensus, replacing native crypto tokens’ liquidity role, competing with and weakening the credit of other tokens, gradually dominating the market for general equivalents.
As a result, we have lost our own market rhythm.
I am not blaming USD-pegged stablecoins; on the contrary, this is the natural result of fair competition and market choice. Tether and Circle help investors directly invest in USD-pegged assets on-chain, exposing them to the risk equivalent to the US dollar and providing investors with more choices.
We are all striving for liquidity!
The millennia-long war for liquidity
Liquidity has always been a true demand.
Liquidity is a fundamental characteristic of the market, and any innovation that can improve market liquidity is a significant progress in history.
According to organizational theory, the market is defined as a structured environment for the exchange of goods, services, and information between buyers and sellers. This environment is guided by established rules, norms, and institutions to facilitate coordination, reduce transaction costs, and support efficient economic interactions.
Liquidity is crucial for market organization because it directly affects market efficiency, stability, and attractiveness. High liquidity reduces transaction costs by minimizing slippage and increasing trading volume. Markets with high liquidity also exhibit greater price elasticity, helping to find more accurate price information. Information economics emphasizes the role of markets in information discovery. In an ideal market, information flows freely, enabling participants to make informed decisions, optimize resource allocation, and achieve equilibrium prices. A market with high liquidity generates reliable information, facilitating more efficient resource allocation.
Whether it is price discovery efficiency, price stability and resilience, or lower transaction costs, these features enhance the market’s ability to attract participants. Therefore, improving liquidity is essential for any market.
Money is an innovation to address liquidity problems.
Academically, there are two mainstream theories about the origin of money. One theory views money as a convenient means of exchange, accepted by the general public and scholars. The other theory comes from David Graeber’s “Debt: The First 5000 Years,” which argues that money originated from debt relationships but also acknowledges the universal equivalent function of money.
In addition to “The History of Money: From Ancient Times to the Present” by Greene Davis and “Capital: Volume One” by Karl Marx, other sources hold similar views on the origin and evolution of money.
For example, in Neil Ferguson’s “The Ascent of Money: A Financial History of the World,” he points out that the development of money also originates from the social demand for an efficient exchange system, starting from barter and gradually evolving into a more complex system using items with intrinsic value.
Similarly, in Felix Martin’s “Money: The Unauthorized Biography,” the author also discusses money as a concept of social technology that developed out of the need for a more efficient exchange system. Martin, like Marx, believes that money is a universal equivalent that originated from a common commodity in the era of barter.
Finally, David Graeber’s “Debt: The First 5000 Years” presents a unique perspective, arguing that money evolved from debt and obligation systems that predate the invention of money itself. However, Graeber’s viewpoint still aligns with the core idea that money is created as a universal equivalent to facilitate the exchange of goods and services.
These resources further emphasize the role of money as a medium of exchange, echoing the views of Davis and Marx.
To summarize, the consensus in academia regarding money is that its function after its birth is as a general equivalent, a product of solving market liquidity. The disagreement lies in whether the starting point of the money carrier is a commodity or debt.
Money is the answer of ancient elites to the market’s liquidity problem before the advent of the value internet, and money is a means to increase liquidity.
The old forces that equated money with liquidity in the past rarely attempted to improve the market’s organizational structure to achieve better liquidity. They have never considered market liquidity without money. Perhaps it’s because they, like fleas trapped in a covered box, have been trapped for too long and have forgotten how high they can jump.
DEX: The power of transformation
The primary goal of any market is to provide the most accurate prices and efficient resource allocation. Every component, mechanism, and structure is designed to achieve this goal. Throughout history, markets have undergone significant changes. Price generation mechanisms have gone through multiple upgrades. To meet different economic needs, markets have developed various settlement procedures, such as dealer markets, order-driven markets, broker markets, and dark pool markets.
With the advent of blockchain technology, we have encountered new limitations and viable solutions to the old liquidity game. We must create innovative ways to address the exchange demand and provide liquidity for tokens.
To summarize, contemporary token trading platforms face a trilemma: 1) sufficient liquidity, 2) efficient pricing, and 3) decentralization.
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The trilemma of exchange
While centralized exchanges like Binance offer the best trading experience, they are also plagued by risks such as fraud and monopolies. In contrast, decentralized exchanges cater to different use cases. For example, Pump.fun offers an extremely sensitive token supply curve, while Curve provides optimal liquidity in most cases rather than price sensitivity. These exchanges adopt various models to meet the trading preferences of their target customers.
Attempts to create on-chain liquidity
Decentralized exchanges have made significant progress in addressing this trilemma and other challenges in on-chain trading through innovative solutions. Uniswap is the benchmark in this sub-industry. The innovation of the Uniswap V2 curve marked the beginning of a new era. Before the “X*Y=C” curve of Uniswap, decentralized exchanges settled on-chain trading demand using order books. Subsequent Automated Market Makers (AMMs) followed Uniswap’s exploration direction and created liquidity pools. In Uniswap V2, liquidity across different trading pairs is interconnected through algorithms. Uniswap V3 introduced concentrated liquidity pools, allowing users to define price ranges for providing liquidity. Uniswap V4 further advances this by offering customizable solutions for liquidity pools.
Curve, which focuses on stablecoin trading, is another example.Protocol has developed its own supply liquidity curve to provide more token liquidity near the scheduled equilibrium point. In response to the challenges of unified liquidity pools, Curve Protocol has invented a multi-dimensional formula that allows users to place more than two types of tokens in a single liquidity pool, thereby sharing liquidity among all tokens in the pool. In practice, CEX has shown better liquidity and pricing efficiency than on-chain pricing systems, which typically lag behind CEX. Hashflow has established a professional market maker pool (PMM) with the help of oracles to connect on-chain and off-chain liquidity.
However, traditional unified curves are expensive for small-scale tokens. Friend.tech has designed steeper unified curves to accommodate small investors who prefer price increases over sufficient liquidity. Inspired by this, Pump.fun uses steep curves when token value is low, but as the value increases, the curve changes to different slopes or even different curves.
The Evolution of Liquidity Pools
MEV, the race for on-chain liquidity
MEV is another battlefield for decentralized trading platforms. Maximum Extractable Value (MEV) refers to the profit that miners or validators make by including, excluding, or reordering transactions in the blocks they generate. It can be seen as a liquidity cost. In a liquidity pool, each exchangeable token (liquidity) is distributed along a price scale, and the liquidity of each price span is limited. Those who can interact with liquidity pool contracts earlier gain advantages by getting better prices. This makes MEV inherently linked to liquidity issues.
MEV’s manifestation in decentralized exchanges comes through sorting transactions to gain favorable liquidity. This competition improves the efficiency of on-chain transactions but also harms the interests of all parties. To retain as much trading value as possible in decentralized trading platforms and return it more fully to participants, developers have built algorithms and mechanisms to intercept MEV generated by transactions at the application layer.
Flashbots, a veteran in the MEV management field, focuses on node revenue distribution. To ensure transparent and efficient MEV distribution, they have established a MEV auction system at the node level. Eden Network pursues similar goals. KeeperDAO combines MEV extraction and staking, allowing participants to benefit from MEV while protecting users from its negative impacts. Liquidity staking project Jito Labs on the Solana network also addresses this issue.
Projects led by Cow Protocol, including UniswapX, 1inch Protocol Fusion, and others, use auction interaction rights to retain MEV within the trading process instead of migrating it to the node accounting level. Intercepting MEV protects active traders and AMM liquidity pools, eliminating the previous dilemma of DEX bribing nodes and losing MEV.
Liquidity dispersion calls for agents to solve problems
As mentioned earlier, token liquidity is dispersed in various customized pools controlled by different protocols on different blockchains or Layer 2 solutions. Polygon has proposed an aggregation layer to collect liquidity from different layers. Initially, some DEX aggregators emerged to integrate liquidity from these different pools. However, after accumulating enough volume, a more effective approach is to create platforms that facilitate competition, such as 1inch and Cow Protocol.
In addition, batch auction mechanisms enhance the role of agents. They introduce a new market mechanism to mitigate liquidity constraints. In practice, traders can place orders at limited prices within a specified timeframe. Batch auction smart contracts collect these orders and bundle them into a batch. Then, the smart contract allows agents to bid on these batches. The agent offering the best price wins the opportunity to settle all potential transactions within that batch.
Batch Auction Mechanism Description by Cow Protocol
Batch Auctions: The Culmination of DEX Development
After years of DEX development, the industry has accepted methods such as batch, auction, and order matching to optimize trading results for all participants. The specific implementation of auction mechanisms varies, but generally, they shift the complexity of optimizing exchange results to professional participants and redistribute the remaining portion to relatively less sophisticated traders.
Batch auctions can solve many DEX problems from multiple perspectives. In addition to MEV redistribution mentioned earlier, batch auctions can do much more. Traders send intentions to smart contracts rather than instructions. These intentions can last several minutes. These intentions are packaged into a batch and proposed to a group of competing specific trading agents. We know that intentions are diverse, and liquidity pools are varied, making optimization a challenge. By delegating professional tasks to professionals, system efficiency can be improved.
Batch auctions maximize value efficiency by sacrificing time efficiency (each transaction intention lasts for several minutes) and compete differently from CEX.
Barter Trade Revival!
Barter trade returns to the stage
As the ancestor of all cryptocurrencies, Bitcoin defines itself as a currency. Decentralized markets are an emerging field with no clear consensus constraints. Barter trade is a native trading model for cryptocurrencies that naturally integrates into this environment.
DEX is often referred to as an “exchange” platform. In its trading model, there are no pre-determined universal equivalent roles. Traders do not have to use fiat or stablecoins as intermediaries. At the liquidity pool level, any trading pair is allowed. Traders can use any tokens they like to exchange for other tokens, incurring the cost of inefficient liquidity.
However, relying solely on liquidity pools for barter trade has significant limitations. There are not enough pairings for all types of barter trades. Due to the structure of liquidity pools, liquidity deployment takes a long time, making it difficult to find balanced prices. Therefore, liquidity must be deployed over a wider price range, leading to scarcity compared to the limited-time demand for intentions. This is where intentions and batch auctions come into play.
Assuming there are multiple potential trade intentions that can meet each other’s needs, supplemented by liquidity from the pool, barter trade will re-enter the market in a more efficient state. With the increased scalability of web3 infrastructure and the addition of more commodities and financial instruments to web3, batch auction smart contracts will capture thousands or even millions of trade intentions per second. Any token can be used as a means of settling other tokens. We will eliminate the liquidity constraints imposed by the dollar in the general background.
Batch auctions: The Key to On-Chain Barter
The revival of barter trade represents a renaissance, responding to market demand.
Historically, when currency was invented, traders had difficulty finding direct barter opportunities to meet their immediate needs. Therefore, they exchanged commodities for a universal equivalent (currency), and then bought what they really needed in another transaction. Once this mode of exchange was widely accepted, it forced real barter demands to be split into at least two steps, and the direct barter market was completely replaced.
Today, on-chain barter demands exist in the form of short-term intentions. Batch auction smart contracts collect these intentions. Anyone, whether human or artificial intelligence agents, can meet the entire trading demand by providing the best bid. If intentions match, there is no need for stablecoins pegged to the dollar. Tokens retain their utility and share liquidity as before. This matching of barter trade demand is based on a global market and a more powerful information matching capability, extending from the tradition of barter culture in cryptocurrency.
In the short term, the existence of intention time span allows arbitrageurs to transfer liquidity across chains and from off-chain to on-chain. For example, an algorithm that discovers price differences between different chains or between DEX and CEX can buy at a lower price and sell at a higher price within a specified time. It may require using financial instruments to hedge market risks to achieve a risk-free state. However, in the future, when on-chain, off-chain, and cross-chain transactions can be executed simultaneously, all transactions can be executed concurrently. This can eliminate the cost of risk and provide the best experience for traders.
Why is it said that barter trade under batch auctions is a milestone in the DEX era?
The reason is simple. If we look back at the history of currency, the right to coin was initially private. According to “Debt: The First 5000 Years”, debt could be personal. Even in modern times, as detailed in “The Monetary History of the United States, 1867-1960”, private individuals were once able to mint silver coins. However, today, all credit is issued by the Federal Reserve. Even Bitcoin is priced in dollars, which is unfortunate for the times. The dollar has overshadowed the brilliance of cryptocurrencies. Barter trade provides an opportunity to reclaim this status, which is the importance of the revival of barter trade.
The development of DEX gives us confidence that we will eventually surpass centralized trading platforms (CEX). In the previous DeFi summer, it was widely believed that DEX would eventually surpass CEX at the right time. How many people still hold this belief today? If we study the development of DEX, the introduction of batch auctions is not a coincidence. This is a deliberate step towards solving liquidity problems, a phased result of continuous technological iteration of DEX. DEX has evolved from merely having liquidity pools to a comprehensive liquidity system with different participant roles, specialized components, and permissionless composability. This progress has been achieved through the efforts of predecessors. Relaxing time constraints, creating differentiated conditions from centralized trading platforms, lets us see more possibilities. It even restores my confidence in DEX surpassing CEX.
A business cycle has passed, and although DeFi giants remain unchanged on the surface, they have undergone transformation internally. Batch auctions are an important milestone, just as important as the invention of liquidity pools. I believe they can realize the dream of DEX surpassing CEX. When barter trade becomes the primary trading model again, we can regain control of our market rhythm.
Postscript
When discussing the future with many industry leaders, I found a general confusion in the market, and the lack of emphasis on technology has led to a lack of confidence. I remember at the end of 2018 and the beginning of 2019, when I was eating hot pot in Chengdu, I talked with a friend about the bright future of DeFi and Ethereum. He spoke passionately about the future of DeFi and Ethereum, even though the price of ETH was less than $90 at the time, his eyes sparkled with excitement.
Just think, when did the development of the industry fall to the point where it needed speculators’ wallets to define it?
DEX is just a small part of the vast DeFi industry. If we observe carefully, we will find that DeFi, and even other fields, are making significant and exciting progress. As long as technology continues to advance and develop without stopping, what do we have to worry about? Dreams will come true.
For all the industry builders who forge ahead, I have only one ancient Chinese poem to offer: “Do not worry that there are no friends on the road ahead, the world recognizes you.”
