In this article, we present two interconnected narratives: the first narrative outlines the technical evolution of DeFi liquidity, while the second narrative emphasizes the transformative impact of on-chain barter from an economic history perspective. In summary, our goal is to affirm that a profound DeFi revolution is imminent, just requiring a little more patience. The 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 internally 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 plummeted to a low point and rebounded to new highs, driven by ETF approvals and expectations of new quantitative easing. However, the prices of most altcoins do not show 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 akin to a casino. Many crypto enthusiasts revel in the excitement of PvP (player versus player). While memecoins were popular in the early stages of the bull market, value tokens were overlooked by the market.
Seasoned players feel that this time is indeed different. Some developers are perplexed, questioning whether cryptocurrencies can truly 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 interests, unethical behavior, and short-term thinking. The market has long been in a dark forest. Apart from the code, there are not many rules to govern participants. These issues have persisted 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 chart below:
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The chart above shows the activity of various crypto equivalents. By looking at the proportion of trading volume, it can be observed that in recent years, the majority of trades have been in USD stablecoins. If the market value of USD stablecoins does not expand, liquidity pools will be drained as new coins are continuously issued.
In the past, due to the bull market of Bitcoin and Ethereum, altcoins rarely lacked liquidity as these coins could become liquidity for others. However, now, most trading pairs are tied to USD stablecoins. Even with the explosive growth in the value of Bitcoin or Ethereum, it 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 stablecoins and other compliant financial instruments are bait. Cryptocurrencies follow the clock of Wall Street.
In October 2014, Tether started 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 indexes, ten times more than 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 tied to a 1:1 ratio of USD reserves. 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, even if settled in USD, can impact the spot price of Bitcoin, especially since Bitcoin futures now account for 28% of the global market.
Wall Street not only has a physical influence on the crypto market but also a psychological influence. Do you remember when we started paying attention to the Federal Reserve’s attitude, Grayscale’s trust unwinding, the FOMC dot plot, and the cash flow of BTC-ETF? All this information psychologically impacts our behavior. Stablecoins are the bait thrown by the US officials. Since we accepted stablecoins pegged to the USD as a means of providing liquidity, they have gained consensus, replacing native crypto tokens’ role in liquidity, competing and weakening the credit of other tokens, gradually dominating the market of general equivalents.
As a result, we have lost our market rhythm.
I am not blaming USD 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 risks equivalent to USD, and providing investors with more choices.
We are all striving for liquidity!
The millennium war of liquidity
Liquidity has always been a real demand.
Liquidity is a fundamental characteristic of markets, and any innovation that improves market liquidity is a significant historical progress.
According to organizational theory, a 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 as it directly affects market efficiency, stability, and attractiveness. High liquidity reduces transaction costs by minimizing slippage and increasing trading volume. A market with high liquidity also exhibits 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.
These characteristics, whether in terms of price discovery efficiency, price stability and resilience, or lower transaction costs, enhance the market’s ability to attract participants. Therefore, improving liquidity is essential for any market.
Currency was an innovation to address liquidity issues.
Academically, there are two mainstream theories about the origin of money. One theory sees it as a convenient medium of exchange widely 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 money’s universal equivalent function.
In addition to “The History of Money: From Ancient Times to the Present” by Greene Davis and “Capital, Volume I” by Karl Marx, there is other literature that holds similar views on the origin and evolution of money.
For example, Neil Ferguson’s book “The Ascent of Money: A Financial History of the World” points out that the development of money also originated from the societal need for efficient exchange systems, starting from bartering and gradually evolving into a more complex system using goods with intrinsic value.
Similarly, Felix Martin’s “Money: The Unauthorized Biography” discusses the concept of money as a social technology that developed out of the need for a more efficient exchange system. Like Marx, Martin believes that money is a universal equivalent that originated from a common commodity in the barter era.
Finally, David Graeber’s “Debt: The First 5000 Years” presents a unique perspective, arguing that money evolved from debt and obligation systems that preceded the invention of money itself. However, Graeber’s views still align with the core idea that money is created as a universal equivalent to facilitate the exchange of goods and services.
These resources further emphasize money’s role as a medium of exchange, echoing the views of Davis and Marx.
In summary, the consensus in the academic community is that the function of money after its inception is as a general equivalent, a product to address market liquidity. The disagreement lies in whether the starting point of the money carrier is a commodity or debt.
Money was the ancient elites’ answer to market liquidity issues before the emergence of the value internet, and money was 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 conditions, as they 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.
The Power of DEX: Transformation
The primary goal of any market is to provide accurate prices and efficient resource allocation. Every component, mechanism, and structure is designed to achieve this goal. Throughout history, markets have undergone tremendous changes. The price discovery mechanism has undergone multiple upgrades. To meet different economic needs, markets have developed various settlement procedures, such as dealer markets, order-driven markets, broker markets, and dark pools.
With the emergence of blockchain technology, we encountered new limitations and also found viable solutions to the old liquidity game. We must create innovative methods to address exchange demands and provide liquidity for tokens.
In summary, contemporary token trading platforms face a trilemma: 1) sufficient liquidity, 2) efficient pricing, and 3) decentralization.
Trilemma of exchanges
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 instead of price sensitivity. These trading platforms adopt various models to meet the trading preferences of their different 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 segment. The innovation of the Uniswap “X*Y=C” curve marks the beginning of a new era. Before the Uniswap curve, decentralized exchanges used order books to settle on-chain trading demand. Subsequent automated market makers (AMMs) followed Uniswap’s exploration and created liquidity pools. In Uniswap V2, liquidity in different trading pairs is connected through algorithms. Uniswap V3 introduced segmented liquidity pools, allowing users to define the price range they want to provide liquidity for. Uniswap V4 further advances this by providing customized solutions for liquidity pools.
Curve, focusing on stablecoin tradingProtocol has developed its own supply liquidity curve to provide more token liquidity near the predetermined balance point. In response to the challenges of a unified liquidity pool, Curve Protocol has invented a multi-dimensional formula that allows users to place more than two tokens in a liquidity pool, thereby sharing liquidity among all tokens in the pool. In practice, centralized exchanges (CEX) exhibit better liquidity and pricing efficiency compared to on-chain pricing systems. However, for small-scale tokens, traditional unified curves are costly. Friend.tech has designed steeper unified curves to accommodate small investors who prefer price increases over sufficient liquidity. As the value of tokens increases, investor preferences shift towards liquidity. Inspired by this, Pump.fun uses steep curves when token value is low, but as the value increases, the curve transitions to different slopes or even different curves.
The evolution of liquidity pools has been influenced by MEV, the race for on-chain liquidity. Maximum Extractable Value (MEV) refers to the profit that miners or validators can obtain by including, excluding, or reordering transactions within their generated blocks. It can be seen as a liquidity cost. In liquidity pools, each tradable token (liquidity) is distributed along a price scale, and liquidity for each price range is limited. Those who can interact with liquidity pool contracts earlier gain an advantage by obtaining better prices. As a result, MEV is inherently linked to liquidity issues.
MEV is manifested in decentralized exchanges (DEX) through the prioritization of transactions to gain favorable liquidity. This competition improves the efficiency of on-chain transactions but also harms the interests of all parties involved. To retain as much transaction value as possible in decentralized trading platforms and return it more fully to participants, developers have built algorithms and mechanisms at the application layer to intercept MEV generated by transactions. Flashbots, as a veteran in the MEV management field, focuses on the distribution of node rewards. 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 effects. Jito Labs, a liquidity staking project on the Solana network, also addresses this issue.
Projects led by Cow Protocol, including UniswapX and 1inch Protocol Fusion, utilize auction interaction rights to keep MEV within the transaction 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.
The dispersion of liquidity calls for agents to solve the problem. As mentioned earlier, token liquidity is scattered in various customized pools controlled by different protocols on different blockchains or Layer 2 solutions. Polygon has proposed the concept of an aggregation layer to collect liquidity from different layers. Initially, some DEX aggregators appeared to integrate liquidity from these different pools. However, a more efficient approach, once sufficient traffic has been accumulated, 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 alleviate liquidity constraints. In practice, traders can place orders at limited prices within a specified time frame. Batch auction smart contracts collect these orders and bundle them into batches. The smart contract then allows agents to bid on these batches. The agent offering the best price will win the opportunity to settle all potential trades within the batch.
Batch auctions, along with other methods such as auctions and order matching, have been accepted by the industry over the years to optimize trading outcomes for all participants. The specific implementations of auction mechanisms may vary, but in general, they shift the complexity of optimizing exchange results onto professional participants and reallocate the remaining portion to relatively less sophisticated traders.
This type of auction can address many challenges faced by DEX from various angles. In addition to the MEV redistribution mentioned earlier, batch auctions have many other benefits. Traders send intentions to smart contracts instead of instructions. These intentions can last for minutes. These intentions are packaged into a batch and proposed to a group of competing specific trading agents. We know that there are massive intentions and diverse liquidity pools, making optimization a challenge. By entrusting professionals with specialized tasks, system efficiency can be improved.
Batch auctions maximize value efficiency by sacrificing time efficiency (each transaction intention lasts a few minutes by default), creating differentiated competition compared to centralized exchanges (CEX).
Moreover, barter trade is making a comeback. As the ancestor of all cryptocurrencies, Bitcoin defined itself as a currency. Decentralized markets are emerging with no clear consensus constraints. Barter trade is a native trading model for cryptocurrencies and naturally fits into this environment.
DEX is often referred to as an “exchange” platform. In its trading model, there is no predetermined universally equivalent role. Traders do not need to use fiat currency or stablecoins as intermediaries. At the liquidity pool level, any trading pair is allowed. Traders can exchange any tokens they like for other tokens and bear the cost of low liquidity efficiency.
However, relying solely on liquidity pools for barter trading has significant limitations. There are not enough pairs for all types of barter trading. Due to the structure of liquidity pools, liquidity deployment takes a long time, making it difficult to find an equilibrium price. Therefore, liquidity needs to be deployed over a wider price range, which results in scarcity compared to the time-limited demand of intentions. This is where intentions and batch auctions come into play.
Assuming there are multiple potential trading intentions that can fulfill each other’s needs, along with liquidity from the funding pool, barter trading will return to the market in a more efficient state. With the improvement of web3 infrastructure scalability and the addition of more commodities and financial instruments to web3, batch auction smart contracts can capture thousands or even millions of transaction intentions per second. Any token can serve as a means of clearing other tokens. We will break free from the liquidity constraints imposed by the US dollar in a universal context.
Batch auctions are the key to on-chain barter trade. The revival of barter trade represents a renaissance and responds to market demand.
Looking back at the history of money, when currency was invented, traders had a hard time finding direct barter opportunities that met their immediate needs. Therefore, they exchanged goods for a universal equivalent (currency) and then used it to buy what they truly needed in another transaction. Once this mode of exchange was widely accepted, direct barter markets were 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 AI agent, can meet the entire transaction demand by providing the most favorable bid. If intentions match, stablecoins pegged to the US dollar are not needed. Tokens retain their utility and share liquidity as before. This matching of barter demands is based on a global market and stronger information matching capabilities, extending from the traditional culture of cryptocurrency barter.
In the short term, the existence of intention time spans allows arbitrageurs to transfer liquidity across chains, 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 within a specified time frame and sell at a higher price. 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 at the same time. This can eliminate the cost of risk and provide the best experience for traders.
Why is barter trade under batch auctions a milestone in the DEX era?
The reason is simple. If we look back at the history of money, the right to mint coins was initially private. According to “Debt: The First 5,000 Years,” debt could be personal. Even in modern times, as detailed in “A Monetary History of the United States, 1867-1960,” private individuals were able to mint silver coins. However, today, all credit is issued by the Federal Reserve. Even Bitcoin is priced in US dollars, which is unfortunate for this era. The US dollar has overshadowed the brilliance of cryptocurrencies. Barter trade provides an opportunity to reclaim this position, highlighting the importance of the revival of barter trade in this era.
The development of DEX gives us confidence that we will eventually surpass centralized exchanges (CEX). During the previous DeFi summer, it was widely believed that DEX would 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. It is a deliberate step towards solving liquidity issues and an iterative achievement of continuous technological advancements in DEX. DEX has evolved from merely having liquidity pools to becoming a comprehensive liquidity system with different roles for participants, specialized components, and permissionless composability. This progress has been achieved through the efforts of pioneers. Relaxing time constraints and creating differentiated conditions compared to centralized exchanges allow us to see more possibilities. It even restores my confidence in DEX surpassing CEX.
A business cycle has passed, and while DeFi giants may appear unchanged on the surface, they have undergone transformations internally. Batch auctions are an important milestone, as significant as the invention of liquidity pools. I believe they can fulfill the dream of DEX surpassing CEX. When barter trade becomes the predominant trading model again, we can regain control of our market rhythm.
Postscript:
In discussions about the future with many industry leaders, I have found a general sense of confusion in the market and a lack of appreciation for technology, leading to a general lack of confidence. I still remember in late 2018 and early 2019, while eating hotpot in Chengdu, I had a conversation with a friend about the bright future of DeFi and Ethereum. He talked 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.
Think about it, when did the industry fall to the point of defining itself with speculators’ wallets?
DEX is just a small part of the vast DeFi industry. If we observe carefully, we will see 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 surely come true.
To all the builders tirelessly working in the industry, I have only one line of ancient Chinese poetry to offer: “Do not worry that the road ahead has no kindred spirits, for who in the world does not recognize you.”
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