Decentralised Trading Platforms, Challenges, Developments & Advancements

For most individuals, trading platforms are the de facto gateway to cryptocurrency. Whether centralised or decentralised, these trading platforms allow many first-time users to acquire cryptocurrency easily. Attempts to ride the previous bull cycles saw numerous teams creating trading platforms to capture the market. Until now, there are still multiple pitch decks circulating each month about a new team trying to start another cryptocurrency trading platform.

Trading platforms have come a long way. With each one promising a new feature, it can be confusing for us to distinguish between innovation or a rehash of something we have seen before. We have to ask ourselves, does this address users’ needs? Or is it simply introducing an excessive level of complexity?

In this article, we will attempt to understand how decentralised trading platforms have evolved to meet the demands of crypto users and how they might eventually improve in the future.

Understanding Transactions: Buyers and Sellers

The fundamental utility of a crypto trading platform is to allow users to participate in a transaction. There are two main parties in a transaction — the buyer and the seller. The buyer provides cash or a cash equivalent in exchange for a product provided by the seller. Both parties would look out for these four main factors during a transaction:

Emulating the Success of Traditional Finance

Traditional trading platforms are able to resolve most transaction issues by aggregating the market. This allows for proper price discovery as demand and supply are concentrated on a single platform. Traditional trading platforms have also invested in quality hardware technology that allows users to participate at various price points with high-speed transactions. Users also tend to be more sophisticated with better access to credit and risk re-allocation products such as insurance. Lastly, systematic checks and balances (traders, brokers, clearing houses, and regulators) have been introduced over time to help introduce stability in the space.

Given the success of traditional finance trading platforms, the cryptocurrency industry could have just replicated the same structure. However, this proves to be a tall order for most crypto trading platforms.

Issues with Crypto Trading Platforms

Most cryptocurrency trading platforms are still unable to fully resolve the four key considerations for both buyers and sellers.

• Lack of liquidity due to fragmentation of users
• Slow transaction speed
• High transaction cost
• Cryptocurrency custody and smart contract risk on AMMs

Building a cryptocurrency platform that can capture the majority of the market and maintain hegemony is challenging. Currently, most of the cryptocurrency flows are concentrated on centralised platforms. Decentralised platforms currently take up about 12.82% of the total spot trading volumes as of March 2023.

Reference

Despite centralised trading platforms aiming to introduce the same efficiency as traditional finance trading platforms, users are still shifting to decentralised trading platforms. Mounting issues of centralisation risk ranging from the collapse of Mt Gox, FTX, technology exploits, and exorbitant listing fees during Defi summer, there is a collective lack of trust.

However, the on-chain LOB format also proves to be a challenge to implement on the blockchain. This is due to the main constraints of blockchain technology for block finality, speed, and gas prices, making it slow and expensive to implement.

Automated Market Makers: Solving High Transaction Costs & Low Liquidity?

Given the challenge to provide instantaneous transactions without the exorbitant cost, Vitalik flirted with the idea of implementing Automated market makers (AMM) from the prediction markets space.

AMMs act like the intermediary market maker provider between the buyer and seller on centralised platforms. Using smart contracts, users can place an order which will algorithmically provide a price based on a given formula.

AMMs unlocked the potential of democratising market-making to the masses. Less-popular cryptocurrencies which are typically avoided by professional market makers due to their risk profile can now tap into their community for liquidity instead. This not only solve liquidity for smaller token projects but unlocked the potential for new players to enter the market making space as liquidity providers.

A Brief Insight into How AMMs Work

The first iteration of AMMs was implemented by Uniswap. As shared in the white paper, Uniswap’s protocol utilises x*y=k constant product formula for users to swap their tokens. Being the first decentralised trading platform, Uniswap helped to usher in a new era of AMMs iterations:

Pushing the boundaries of AMMs

Since the first successful implementation of AMMs in 2018, multiple iterations of AMMs have been introduced to help provide a better transaction standard for users.

Being the first type of AMM implemented, Constant Product Market Markers (CPMMs) initially allowed users to swap between two tokens at any time in a cost-efficient manner on the blockchain. Balancer eventually introduced Constant Mean Market Makers (CMMMs) which allowed users to trade with more than two tokens which are correlated in value.

However, with both CPMMs and CMMMs using the same constant function formula, there can be steep slippage for tokens at times of poor liquidity. This is an issue for decentralised trading platform users who wish to transact like-to-like tokens such as USDT/USDC.

The Hybrid Function Market Maker (HFMM) attempts to resolve this issue with high slippage by integrating the exchange functions of a CSMM and a CPMM/CMMM. The mix of a CPMM/CMMM and a CSMM emphasises both their advantages and minimises their problems. Hence, Curve Finance introduced hybrid function market makers (HFMM) to reduce slippage for relevant trading pairs.

While the AMMs focused on providing a better transaction experience for users, there was an added layer of complexity of having to incentivise liquidity providers. This ushered in the concentrated liquidity-orientated AMMs, such as Uniswap v3, and Dynamic Automated Market Makers, which aims to innovate on ways to reduce impermanent loss exposure. However, these platforms are not able to fully resolve the impermanent loss issue.

Potential Solutions for Decentralised Trading Platforms

In the above article, we were focusing on how decentralised trading platforms were addressing the needs of buyers, sellers, and liquidity providers. However, as with any technology innovation, it is also important to recognise the hardware limitations.

The issues to tackle for decentralised trading platforms can be categorised into three broad categories:

1. On-chain technology limitations
2. Fulfilling transaction standards for users (buyers and sellers)
3. Fulfilling liquidity providers’ needs

Unlocking On-chain Technology Limitations

Currently, it is still not possible for multiple transactions to occur seamlessly without issues with block memory space, cost, and transaction speed. In order to curb these limitations, we can either complement existing blockchains with feature upgrades or build a new blockchain.

Here are a few examples of solutions that are pushing the boundaries of blockchain technology for decentralised trading platforms.

1. A hybrid model integrating off-chain capabilities — Off-chain settlement, Off-chain custody, Off-chain sequencer
2. Building a new blockchain with better capabilities — Transaction speed, on-chain memory storage, and Transaction throughput
3. Scaling existing blockchains — Roll-ups, privacy-focused
4. Oracles & nodes — Pricing oracles

Setting the New Standard for Users and Liquidity Providers

By improving blockchain technology, decentralised trading platforms can then focus on providing more value to users and liquidity providers. These values should be targeted in attracting and maintaining liquidity or trades in a sustainable manner.

Here are some areas of innovation decentralised trading platforms can implement to help improve the user experience :

1. Community growth and retention — New sustainable governance methods to help attract users and stakeholders
2. AMM execution methods — New or better algorithmic formulas
3. Solutions to prevent impermanent loss — New methodology or derivatives solutions to abstract the risk
4. Seamless UX/UI — Intuitive and sticky trading tools

Without tackling these issues head-on, chances are the projects are just adding a feature or introducing unnecessary complexity to the project.

Conclusion

The age-old chicken-and-egg issue of liquidity provision still stands as it is tough to provide liquidity without users, and attracting users without liquidity is no easy feat. Decentralised trading platforms still have a lot more to build, in order to allow more users to utilise them as readily as a centralised trading platform.

At DWF Ventures, we would be glad to explore opportunities with bold founders who are currently working to push the boundaries. We look forward to supporting projects which are building the next generation of decentralised trading platforms.