Let’s face it. Although we have seen tremendous TVL growth in decentralized exchanges (DEXs) lately, there are still major issues that need to be addressed in order for them to be adopted by the masses.
Most of the DEXs nowadays are in the form of swaps protocol, meaning it only allows users to do spot trading by swapping one token for another. The underlying mechanism used is called Automated Market Maker (AMM) and all transactions are settled on-chain.
At sat.is, we believe that there are improvements to be made and came up with a derivatives exchange to address the challenges that we have seen. In the following part of the article, we are going to look through what are the issues that plague the current DEXs.
Fragmented Liquidity Pools
Liquidity is arguably the most important essence in DEXs. High level of liquidity is required for any traders to get into and out of their trades easily. With many DEXs emerging across different blockchains, liquidity is widely dispersed, resulting in low levels of liquidity on many individual DEXs.
This fragmented liquidity issue harms both traders and liquidity providers (LPs). Traders are at risk of high slippage (will be explained below) when making their trades while LPs’ funds are not utilized efficiently.
With blockchain interoperability looming, it is vital for a DEX to pool and concentrate fragmented liquidity from different chains to provide the best experience for users.
Scalability issues
Low throughput and efficiency makes it difficult for DEXs to scale. The more users there are on DEXs, the more trade orders there are to be settled on-chain. This leads to congestion of the underlying blockchain network, resulting in longer settlement periods and high transaction fees. This issue is especially apparent on Ethereum.
The Blockchain Trilemma perfectly sums up this scenario:
The trilemma depicts every blockchain’s conundrum, that is to achieve high security, high scalability and decentralization, without compromising one of these attributes.
The scalability issue has to be addressed as it is one of the primary bottlenecks for greater adoption of DEXs moving forward.
Traditional AMM’s flaws
While we cannot deny that AMM has it’s pros — it allows any users to provide liquidity easily, there are reasons that DEXs that operate only on AMM would not cut it in the long run.
For most traders, advanced order types (eg. limit order, stop order, time-in-force) and/or leverage trading are crucial to their trading strategies. Unfortunately, as of now, the AMM mechanism is still incapable of providing such features.
Therefore, it goes without saying that the next generation DEXs must provide a CEX-like experience while keeping true to its decentralized ethos.
High slippage
Slippage is the price difference between when a user submits a transaction and when the transaction is confirmed on the blockchain.
The undesirable high slippage issue is common on AMM DEXs, leading to unexpected trade outcomes and thus eating into the profits of traders. There are 2 scenarios which cause slippage to occur in an AMM DEX.
Slippage caused by high price volatility
As mentioned earlier, there is a time lag between a user submitting a transaction and the transaction being confirmed on a blockchain. During times of high volatility, prices change a lot in a short time interval. By the time the transaction is confirmed on the blockchain, the actual amount of cryptos bought may vary a lot from what it was initially seen by the user.
Slippage caused by low liquidity
AMM DEXs are really just protocols with crowdsource liquidity equipped with smart contracts which allow users to trade with that liquidity. Each liquidity pool contains a 50/50 split of two crypto assets.
When a user trades, he/she is essentially depositing one token and withdrawing the other. The algorithm sets an automatic price based on the availability of the crypto assets in the pool. Hence, the lower the liquidity in a pool, the more susceptible a trade is to high slippage.
Final Thoughts
The art of creating a successful product is to always know what the market wants. For traders, it is an exchange with high level of liquidity, low cost, high efficiency and the ease of use.
We at sat.is foresee the need to create an improved version of a decentralized exchange. Our multichain derivatives exchange uses a combination of our unique AMM and order book to match trades, providing features like advanced order types and leverage trading for traders while ensuring high capital efficiency for LPs. All users can take comfort in having their funds under their own custody while interacting with the sat.is platform.
More importantly, sat.is concentrates liquidity from all the chains that it operates on to ensure a seamless experience for traders and LPs alike.
For partnerships and business inquiries: team@sat.is
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