LavaSwap Research: DEXs 101 (Decentralized Exchanges) 🔥📚
LacaSwap’s mission is to make DeFi fun and easy to use. So we wanted to ceate a series that can help educate those that are crypto-curious. We call this educational series LavaSwap Research.
Decentralized exchanges are automatic and unstoppable exchanges where people can swap their crypto assets with other users, without the need of control and supervision from a central entity.
In the early days, when blockchain technology was new and Bitcoin unknown, it was difficult to access cryptocurrencies. There was a need for places to trade cryptocurrencies, and centralized exchanges were born.
They were controlled by third-parties, that were in charge of security, protecting user’s data, reliability, etc.
Basically they functioned the same way as traditional exchanges: places that connected buyers with sellers through a centralized platform.
Since then, CEXs (centralized exchanges) have suffered hacks & a lot of funds have been stolen, like the famous Mt. Gox case.
The Birth of DEXs
Decentralized exchanges have been developed since 2013, so they are nothing new. However, only with the popularity of DeFi they have been able to shine, because they lacked one crucial aspect: liquidity.
Before DeFi, DEXs were considered a dream by many, as they didn’t have enough liqudity, users, and were generally harder to use than CEXs.
Uniswap changed the game
On the Ethereum network, Uniswap is the most well-known DEX. Its growth has been spectacular, and it has opened the way to new and exciting DEXs across the crypto space.
Source: DEFIPULSE
Uniswap showed the crypto space that decentralized exchanges can become really big (Uniswap even surpassed Coinbase Pro in daily volume! https://cointelegraph.com/news/defi-explosion-uniswap-surpasses-coinbase-pro-in-daily-volume. Coinbase is one of the biggest crypto exchanges in the world!).
Uniswap made it possible for people to interact and exchange cryptocurrencies without third-party involvement, allowing users to have more freedom when it came to their assets, and providing liquidity for great projects that didn’t have strong volume.
It also showed the crypto world that DEXs don’t have to compromise on user-friendly interfaces, and they don’t need to be complicated to use.
Advantages of DEXs
With the right amount of innovations, DEXs can make trading cryptocurrencies :
- More accessible: no need for KYC or long registration processes.
- Safer: DEXs don’t control your crypto assets at any point. You only connect to the platform, so the risk for failures, hacks and stealing of funds is significantly reduced.
- More reliable: you can see what’s happening on the platform at any point, and know in advance how the platform will resolve any situation.
- Cheaper: no need for intermediaries, big databases or employees.
- Easier access to assets: as any token can be listed on a DEX, the number of cryptocurrencies is bigger than in CEXs.
How Do DEXs Work?
Traditional exchanges are easy to understand: there’s a place that connects buyers and sellers through a third-party.
Decentralized exchanges connect buyers and sellers directly, through the use of smart contracts. Those are instructions written with the use of blockchain technology.
There are a wide number of DEXs, with different technologies, but they can usually be divided on three categories: on-chain, off-chain and automated market makers (AMM).
On-Chain DEXs
The exchanges orderbooks (the written records of sellers sell orders and buyers buy orders) are on chain, which means every order of every user gets recorded on the blockchain.
This would, in theory, be the safer DEX, because it’s fully using blockchain technology. But in reality, it adds cost (because you have to pay miner’s fees for every order) and time, because every user has to wait until every transaction is recorded.
Off-Chain DEXs
The exchange orderbooks are hosted outside of the blockchain, but every transaction is made and recorded on-chain.
This is a hybrid approach that allows faster speeds, as not every order needs to be recorded on the blockchain, but every trade needs to, so their speed is not as fast as DEXs.
Automated Market Makers (AMM)
AMMs don’t require orderbooks (buying and selling orders), but rather provide a system of incentives for the users to provide the liquidity.
Every AMM is different, but the general idea is that they use smart contracts to create liquidity pools that helps user make trades automatically.
Instead of interacting with another user, you interact directly with a smart contract, that connects you with a liquidity pool of assets.
A liquidity pool is a stack of funds (crypto assets) that provide users with liquidity for different trading pairs.
Liquidity providers (LPs) add funds to those liquidity pools, and in exchange they earn fees from the trades or other type of incentives.
AMMs are interested in attracting liquidity because if there’s small liquidity, you could end paying more for the same order (this is called slippage in trading).
Yield Farming
Yield farming is the practice of staking or lending crypto assets in order to generate high returns or rewards in the form of additional cryptocurrency (Source).
In short, it is about putting your cryptocurrencies to work to generate more cryptocurrencies.
On decentralized exchanges, it is very common to reward people that add liquidity to a certain cryptocurrency with a token. This is called liquidity mining, and profits are usually expressed in annual percentage yield (APY).
How to calculate APY
APY takes into account compound interest, which means that the tokens you get generate more tokens overtime.
The formula to calculate APY is the following
APY= (1 + r/n )^n -1
- r is the annual interest rate (example 1%, 2%, 0.5%)
- n is the number of compounding periods each years (It could be 12 months, 365 days, etc.. This number depends on the payments offered by the Yield Farm)
Example
With an annual interest rate of 7%, and payments each month (12 months), the APY would be:
APY= (1 + 0.07/12)¹²-1= (1.00583333…)¹²-1≈ 1.07229–1≈0.07229≈7.23% APY
How to calculate your return knowing the APY
This one is simple! You just have to multiply the % APY for the number of tokens you are providing to the pool.
Example
With an APY of 1083% and 20000 tokens, at the end of the year you would get: 1083% x 20000= 216600 tokens. Not bad!
This is why it is important to participate early into good Yield Farming Opportunities. The returns could be incredible! Remember, always DYOR! 🕮
LavaSwap AMM
LavaSwap is building the first interoperable decentralized cross-chain swap protocol powered by Huobi Eco Chain.
We are creating an automatic market making DEX. We envision a world where all crypto assets can come play in our BLAZING DeFi playground.
We believe that DeFi should be fun, simple, and easy to access.
We are the first foreign-based #HECO project that reached a TVL of over $200 million in just 11 days since launch! 🔥
Remember, in order to use LavaSwap, you need to connect your HECO (Huobi Eco Chain) wallet. To learn more about how to use lavaSwap check here.
In order to expand the DEX ecosystem, we had to create something that
1. Was fast & reliable
2. Was secure
3. Was fun & exciting to use
4. Was unique, with cross-chain capabilities
For LAVA, we want interoperability to be front and center.
While we think the ETH network is great, DeFi does not belong only to one chain. It should be accessible for everyone.
As DeFi grows further, interoperability and opening access to emerging ecosystems such as HECO will enable greater mainstream adoption.
Cross-chain is a must because DeFi should not be limited by individual networks, because the average consumer would want an end product that is simple to use and accessible. After all, that’s the whole premise of DeFi!
Lava’s Cross-chain bridge will open up assets to play across the whole crypto world.
We are following the steps of giants, and will continue to work hard on the DEX space to provide users with the best experience possible when trading cryptocurrencies and discovering the possibilities of DeFi.
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LAVA is a the first interoperable decentralized cross-chain swap protocol powered by Huobi Eco Chain. We believe that DeFi should be fun and easy to use for everybody!
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