Background
Background -DeFi Ecosystem
Last updated
Background -DeFi Ecosystem
Last updated
Decentralized finance (DeFi), both in terms of product offerings and user adoption, have experienced tremendous growth. Numerous blockchains have been used to implement a wide range of financial products that are distinguished by decentralization, high accessibility, and trustless transactions. The total value locked (TVL) in DeFi climbed from $1.08 billion to $53.18 billion in 2021. At the same time, the TVL of the Ethereum blockchain rose by an amazing 771%. One of the most well-known and widely utilized DeFi proutilizeds is Uniswap, an Ethereum-based decentralized exchange (DEX) with a fully diluted market value of $5.8 billion as of July 12th, 2022.
Since the summer of 2021, several concepts with enhanced protocols and liquidity pool topologies have emerged. These systems essentially make an effort to manage liquidity more intelligently, therefore raising annual percentage yield (APY), reducing risks associated with short-term losses, and generally enhancing the user experience for liquidity providers. These distinct protocols, which are leaders in the field of DeFi innovation, have sparked interest in researching their potential developments and effects on the DeFi ecosystem, which is rapidly increasing.
During our market study, we found that the current DEXs had several architseveralws that caused traders to experience high slippage and price impact as well as temporary losses and bad APYs for liquidity providers:
Nonlinear distribution of liquidity: Manual control of liquidity allocation results in a nonlinear distribution of liquidity across pools. This lopsided allocation might have significant price repercussions and slippage when traders execute large deals with low TVL.
Manual liquidity management: Liquidity providers must manually determine, keep track of, and modify the liquidity allocations they make across various pools. This approach wastes money in addition to being time-consuming and prone to mistakes. Lower APYs and greater risks of momentary loss might be outcomes of insufficient liquidity management.
50/50 pool architectures: The pool structure of traditional DEXs is usually 50/50, requiring liquidity providers to contribute equal amounts of both tokens to the pool. In particular, if the price of one token changes dramatically, this structure may subject liquidity providers to greater short-term loss risks.
High price impact and slippage: Because of the nonlinear liquidity distribution, traders commonly experience high price impacts and slippage on their trades, which causes financial losses. This situation also creates opportunities for arbitrage, which causes DeFi protocols to lose assets and value.
Concentrated liquidity: Some DEXs make use of concentrated liquidity, which enables liquidity suppliers to choose a price range in which they intend to provide liquidity. Although this method can increase capital efficiency, it also exposes liquidity providers to short-term loss risks when the market deviates from the agreed range.
In conclusion, the present DEX ecosystem's design flaws and problems result in high slippage and price effects for traders, as well as transitory loss risks and low APY for liquidity providers. Although efforts have been made to solve these issues, no known solution has eliminated losses for both parties. Novel solutions that could solve these problems and enhance the whole DeFi experience are therefore urgently needed.
