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What are the Requirements for Decentralized Exchanges to Achieve High Liquidity?

Even if all centralized exchanges are closed, leaving us with no option but the decentralized ones (DEXs), can these platforms handle the high liquidity that Binance, Coinbase, or Bithumb are facing today?

We’re going to take a deeper look into this question and identify the requirements for DEXs to achieve high liquidity, while at the same time try to spot the potential candidates that can bring a workable solution to the table.

Liquidity is a challenge for the entire cryptocurrency market

In the cryptocurrency market, liquidity refers to the difficulty of an asset to be bought and sold at a fair price. Lower liquidity creates a more volatile market, where prices change substantially in a shorter period of time. Higher liquidity makes for a stable, less volatile market where prices do not fluctuate as significantly. High liquidity is always desirable, not just in cryptocurrency but in any market.

Low liquidity causes price slippage.

In a volatile market, the delay between placing a trade and having it executed could be enough for the price to go up or down significantly. If the movement is against your desired trade, you could lose money. Ideally, the order price (the one you asked for) should be close to the executed price (the one you actually get). In an exchange with low liquidity, however, this isn’t possible due to the lack of traders, thereby increasing the risk with every trade.

Currently, the most liquid asset is fiat currency. The market is able to easily absorb any transaction without causing a drastic change in the value of the dollar. There’s almost no risk involved for either the buyer or the seller. The value of the currency (the US dollar, euro, yen, etc.) is known at the time of the transaction along with the costs associated with it.

For example, one million US dollars will keep its value before and after the transaction, and the commission is calculated based on the intermediary (bank, broker, etc.) in the same stable currency. However, for that same transaction, using one million dollars worth of Bitcoin, or any other cryptocurrency, in a low liquidity market not only has a greater effect on the cryptocurrency’s price but it could end up costing even $100,000 more (or less) than the original price when making the trade. The risk is on both sides.

Centralized exchanges

In the past few years, the liquidity of the cryptocurrency market had its ups and downs. In 2017, before the “hype” started, the total market capitalization of all cryptocurrencies (including Bitcoin) was only $16 billion. In a single year, it went up to over $800 billion. Currently, we are perceiving the prices being at an all-time low even if we are sitting on a $120 billion market cap and a 24-hour transacted volume of $16 billion. This amount was representative of the entire cryptocurrency market two years ago and is now being traded on a daily basis!

Who is handling the liquidity of this transaction volume? Mostly centralized exchanges with an astonishing 99.8% of all market transactions. The other 0.2% is on the DEXs.

With most of the centralized having been hacked in the past, we can’t overlook the benefit of using a decentralized exchange where there is no need to put any trust in the exchange platform itself, as the funds are held by each user in their own personal wallet. Not to mention the increased privacy and the reduced risk of server downtime, which makes DEXs the clear winner between the two.

So what keeps traders from jumping ship? The low liquidity on DEXs.

DEXs: a deserted market

What do the decentralized counterparts need in order to increase their liquidity? There are three requirements and none of them can’t work without the other:

  1. Usability
  2. Traders
  3. Scalability

Let’s figure out how close are we to having a solution that checks them all and offers high liquidity.

Offering a seamless user experience

The easiest issue to solve is offering, at the very least, the same user experience as their centralized counterpart. If they want traders and average users to consider using their platform, the “cost” of switching to a new platform should be reduced as much as possible.

There are a few essential points to be consider:

  • The interface should be familiar (the market leaders (Binance, Bittrex, and Bitfinex) are currently setting the standard)
  • Offering the same features for any trader (conditional orders, stop-loss, access to reports, etc.)
  • Integrating trading analysis tools (having their tools incorporated directly into the exchange is a must)

Once these points are settled, there are things to consider in order to remain competitive in the market, such as offering lower fees, support for other cryptocurrencies, and various trading pairs.

ForkDelta’s solution was to offer as many tokens as possible by coming up with a permissionless token-listing system to simplify the token submission process. Even if this approach is aligned with their community-driven, open-source vision, the market didn’t embrace the other shortcomings coming with the use of this decentralized exchange. The promise of a new user interface has been around since the beginning of last year, but there are no signs of them being close to implementing it. The liquidity remains low on ForkDelta and reinforces our belief that user experience aspects are an important factor.

BitSquare has also had a great evolution, reaching 126 tradable cryptocurrencies while having every aspect decentralized; from placing the order to matching or executing that order. The ones who will be able to lower the barriers of switching from one exchange to another (allowing users to exchange any token within one platform) can score high marks in overall usability. Unfortunately, BitSquare is not there yet, as they have only sorted these tokens into 11 tradable pairs. The delay of selling one currency for BTC to then use that BTC to buy another token can cost a trader a lot of money.

What looks promising is the solution coming from VDEX, which not only eliminates specific trading pairs with cross-chain liquidity pools and comes up with a modern color-driven user interface but, being part of a more complex DAE (digital assets ecosystem), they are making a step forward by offering an analytics engine, Vespucci, to their users. This engine displays a list of all available coins and a selection of the top-ranked coins based on fundamental, technical, and market sentiment analysis data that a trader can use to their advantage. It’s the first time we’re seeing an intuitive UI interaction in accessing and viewing data for a user’s interest in an exchange and, in terms of user experience, this might just push the standards even higher.

Bringing a lot of traders

Having all the features in place and offering a seamless user experience could be part of the second requirement: having as many traders as possible on their DEX so the liquidity increases organically.

But there is another way that programmatically solves the liquidity problem by sharing it.

One solution comes from Dexdex, which is a service that searches multiple exchanges, protocols, and market makers while trying to ensure the best available price. They are able to achieve this by aggregating the data from other platforms through their APIs (application programming interface). Leveraging their open trades, it might offer the trader the experience of trading against all other users, thus faking internal liquidity. It might sound ideal in theory, although the best price is not always the best available in the open cryptocurrency market. It’s just the best price between the aggregated sources.

This very approach was also adopted by Easytrade, pooling orders from multiple DEXs. They actually automated the process for the trader: the user indicates the number of tokens he or she wishes to buy or sell and the AI will execute the order at the best rates from the other exchanges. However, the transaction time is the highest among other DEXs. Having the transaction guaranteed is an important thing for anyone who just wants to buy some tokens at the best rate, but for a professional trader, the delay is unacceptable.

In this case, we’re seeing the solution somewhere in between. Pooling liquidity from the other DEXs, sharing the traders that are scattered between the multitude of available choices, all while making sure there are enough traders on the platform. Between these platforms we can mention, who are offering a white-labeled solution for any DEX or dApp willing to join their pool, along with VDEX, who will use the Bancor algorithm price discovery formula in order to augment liquidity and bring stability to their tradable assets.

Being able to scale

Top-notch user experience will bring a high volume of traders which should bring forth the missing liquidity. What’s missing though? It’s not that there’s something missing, it’s more about what’s required when the traded as volume increases way over the DEX’s capacity.

A decentralized exchange allows for securely matching and handling order books in a decentralized manner. This is done on-chain (on the blockchain). A big volume of transactions means that not all of the orders will fit in the next block. Waiting for the next one can create delays that would bring the price change problem back. We might get the liquidity, but if the placed order is not executed in the shortest time possible then we’re still facing an issue.

One way to fix this is by using “atomic swaps” for order matching. An atomic swap is when a trade, instead of being made into two separate transactions (buyer sends first, seller sends second), the order is filled in a single (atomic) operation. Technically, a smart contract acts as a trustless escrow that holds onto one currency until the other user sends their currency. This increases transaction speeds.

BarterDex, a DEX running on the Komodo platform, recently achieved 60,000 atomic swaps, but their trading volume is still low and we’re not sure if their technology will scale by itself. BlockDX has a similar approach running atop of the Blocknet Protocol, allowing users to maintain control of their tokens and private keys during the atomic swap. Between the examples previously mentioned, VDEX is leveraging the same atomic swap technology along with the loopring protocol, using EOS.IO contracts as nodes that allows them to scale off-chain while maintaining the on-chain advantages.


The major challenge with most DEX’s is liquidity. The one who will have the trading volume of Binance or Coinbase will set the standard. It doesn’t matter if the final solution will be sharing a pool as proposes or combining multiple technologies as VDEX does. In any case, the latter has been rather interesting in our research. Not only is the UI up to today’s standards, but in terms of solving the liquidity problems, they are building an ecosystem with interoperable elements, supporting each other. For example, the comprehensible multi-blockchain information extracted via the Vespucci analytics engine aggregates blockchain timelines to determine block production coincidences between chains to access greater liquidity. How smart is that? Anyway, 2019 could be the year when DEXs will flourish. It’ll be good to keep an eye on the best contestants!

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