Have we lost our grip on the rhythm of the crypto industry?

Since January 2023, bitcoin has experienced a rollercoaster ride, plunging to lows and rebounding to new highs, driven by the approval of ETFs and expectations of renewed quantitative easing. However, the price performance of altcoins has diverged from the trend of previous bull runs, failing to exhibit the same exuberance as bitcoin gains traction. This divergence has fueled skepticism among some investors, who scoff at genuine innovation and view the crypto space as a haven for crime, given the performance of VC-backed tokens characterized by high valuations and low liquidity. At industry gatherings, some even go so far as to label the entire industry as akin to a gambling den. Many crypto enthusiasts remain enthralled by the thrill of PvP (player-versus-player) dynamics. Overall, the market has witnessed a surge in the popularity of memecoins during the early stages of the bull run, while value-oriented tokens have been largely overlooked, missing out on the entire bull cycle.

Amidst this bull run, many experienced veterans sense a different atmosphere, one that surpasses even the chilly winter of 2018-2019. Some developers are grappling with doubts, questioning their initial motivations for entering the crypto realm: can cryptocurrencies truly transform the real world? With the rise of AI in recent years, many have shifted their focus towards artificial intelligence, while others remain hesitant.

Why is the cryptocurrency market different this time?

We cannot ignore the impact of greed, misaligned interests, unethical behavior and short-term thinking in venture capital and teams. The market has been in a dark forest for a long time. There aren’t many rules to regulate the participants other than the code. Although these problems have existed for a long time, they are not enough to explain the weakness of this bull market.

Therefore, we propose an additional reason: the self-inflation within the crypto market is no longer sufficient to provide the necessary liquidity for our crypto ecosystem. Please look at the picture below:

(Source: https://www.fixing.finance/report/the-future-of-stablecoin-design)

The chart above shows the activity of various cryptographic general equivalents. It can be seen from the figure that since 2018, the market share of non-stable coins has continued to decline. Judging from the proportion of transaction volume, in the past year or two, most transactions have been provided by US dollar stablecoins. If the market value of US dollar stablecoins cannot continue to expand, as new coins continue to be issued, the liquidity pool will be drained.

In the past, Bitcoin and Ethereum served as the primary liquidity providers within the crypto market. They facilitated liquidity for other tokens, driving a synergistic bull run where altcoins and mainstream liquidity providers (such as Bitcoin and Ethereum) experienced reciprocal upward spirals. This token-centric liquidity structure ensured that altcoins rarely suffered from liquidity shortages. However, the current market landscape is starkly different. Most trading pairs are now pegged to stablecoins, which are backed by fiat currencies. Even explosive growth in the value of Bitcoin or Ethereum is rendered ineffective, as the dominance of stablecoins hinders the ability of BTC and ETH to inject liquidity into other tokens.

The control over cryptocurrency pricing falls into the hands of Wall Street

Fiat-pegged stablecoins and other compliant financial instruments serve as enticing lures within the crypto landscape, subtly aligning the crypto market with Wall Street’s rhythms.

In October 2014, Tether emerged, offering a stable digital currency that bridged the chasm between cryptocurrencies and fiat currencies, providing the stability of traditional money with the flexibility of digital assets. Today, Tether stands as the third-largest token by market capitalization. Notably, USDT boasts the highest number of trading pairs within indices, surpassing both Ethereum and wBTC by a factor of ten.

In September 2018, Circle, in partnership with Coinbase, launched USD Coin (USDC) under the Centre Consortium. Pegged to the US dollar, each USDC token is backed by a corresponding USD reserve in a 1:1 ratio. As an ERC-20 token, USDC facilitates seamless transactions and integration with various decentralized applications.

On December 10, 2017, the Chicago Board Options Exchange (CBOE) became the first to introduce Bitcoin futures. Despite being settled solely in US dollars, these futures significantly impact Bitcoin’s spot price, particularly considering that Bitcoin’s open interest currently accounts for 28% of the global market.

Wall Street’s influence extends beyond the physical markets, deeply impacting the psychology and liquidity dynamics within the crypto space. Recall our collective attention to the Fed’s stance, Grayscale’s trust de-risking, FOMC’s “dot plots,” and the BTC-ETF’s cash flows. These factors collectively influence our behavior, shaping market sentiment.

Stablecoins serve as a Trojan horse, subtly introduced by the US government. By embracing fiat-pegged stablecoins as liquidity providers, we have inadvertently paved the way for their dominance, replacing the liquidity role once held by native crypto tokens. This competition undermines the credibility of other tokens, gradually establishing the US dollar as the prevailing universal equivalent of value within the crypto market.

This way, we have surrendered our own market rhythm (of crypto.)

While I do not intend to vilify US fiat-pegged stablecoins, their dominance is a natural consequence of fair competition and market choices. Tether and Circle have empowered investors to directly invest in dollar-pegged assets on-chain, enabling them to assume risks equivalent to the US dollar while offering investors greater choice.

The crypto market grapples with the pursuit of liquidity. By relinquishing control over liquidity, we have also surrendered our ability to dictate the rhythm of the crypto industry.

The Millennium War on Liquidity

Liquidity is always the true underlying need

Liquidity stands as a fundamental characteristic of any market, and any innovation that enhances market liquidity represents a significant historical advancement.

According to organizational theory, markets are defined as structured environments where buyers and sellers engage in the exchange of goods, services, and information. These environments are guided by established rules, norms, and institutions that facilitate coordination, reduce transaction costs, and support efficient economic interactions.

Liquidity plays a pivotal role in market organization, directly influencing market efficiency, stability, and attractiveness. High liquidity lowers transaction costs by minimizing slippage and increasing trading volume. Highly liquid markets also exhibit greater price elasticity, better prices, attract more participants, and contribute to the discovery of more accurate price information. Information economics underscores the role of markets in information discovery. In an ideal market, information flows freely, enabling participants to make informed decisions, optimize resource allocation, and achieve equilibrium prices. Highly liquid markets generate reliable information, facilitating more efficient resource allocation.

Whether it concerns price discovery efficiency, price stability and resilience, or lower transaction costs, these characteristics enhance a market’s ability to attract participants. Market attractiveness, in turn, further strengthens market liquidity, boosting efficiency across all aspects of the market. Consequently, enhancing liquidity is essential for any market.

Currency is an innovation to alleviate liquidity challenges

In the realm of academia, two primary schools of thought prevail regarding the origins of currency. One perspective, widely accepted by many scholars, views currency as a convenient medium of exchange, facilitating transactions among individuals and businesses. The other, championed by David Graeber in his seminal work “Debt: The First 5,000 Years,” asserts that currency emerged from debt relationships while acknowledging its role as a universal equivalent of value.

Beyond the works of Glenn Davis (“A History of Money: From Ancient Times to Present Day”) and Karl Marx (“The Capital: Volume I”), other sources echo similar views on the origins and evolution of currency.

For instance, Niall Ferguson, in his book “The Ascent of Money: A Financial History of the World,” highlights that the development of currency also stemmed from society’s demand for efficient exchange systems, transitioning from barter to more complex systems utilizing items of intrinsic value.

Similarly, Felix Martin’s “Money: The Unauthorized Biography” explores the concept of money as a social technology, developed out of the need for more efficient exchange mechanisms. Martin, like Marx, views money as a universal equivalent of value, originating from a common commodity in pre-monetary eras.

Lastly, David Graeber’s “Debt: The First 5,000 Years” offers a unique perspective, suggesting that currency evolved from systems of debt and obligation, which predated the invention of money itself. However, Graeber’s view still aligns with the core notion that currency was created as a universal equivalent to facilitate the exchange of goods and services.

These additional resources further emphasize the role of currency as a medium of exchange, echoing the views of Davis and Marx.

In summary, the academic consensus on currency suggests that its primary function upon inception was as a general equivalent of value, a product of addressing market liquidity concerns. The divergence lies in the debate over whether the currency medium originated from commodities or debt.

Currency served as the ancient elites’ response to market liquidity issues before the advent of the value internet. Currency is a tool for enhancing liquidity.

The old guard, which equated currency with liquidity in the past, rarely attempted to improve market organizational structures to achieve better liquidity conditions. They never considered how to establish market liquidity without currency. Perhaps it’s because they’ve been trapped in a box for so long that they’ve forgotten how high they can jump.

DEX: The power of transformation

The primary objective of any market is to provide the most accurate prices and the most efficient allocation of resources. Every component, mechanism, and structure is designed to achieve this goal. Throughout history, humans have continuously devised new methods to enhance market efficiency.

Over centuries, markets have undergone profound transformations. Price discovery mechanisms have witnessed multiple upgrades. To cater to diverse economic needs, markets have developed various settlement procedures, such as dealer markets, order-driven markets, broker markets, and dark pools.

With the advent of blockchain technology, we encounter new limitations and also unlock new opportunities to address liquidity challenges. By harnessing the power of blockchain, we can create innovative approaches to address exchange demands and provide liquidity for tokens.

In summary, contemporary token exchanges face a trilemma: 1) Ample liquidity, 2) Effective pricing, 3) Decentralization.

The exchange trilemma

While centralized exchanges, exemplified by Binance, offer the most streamlined trading experiences, their users remain susceptible to fraud risks and monopolistic exploitation. Even FTX, once the world’s second-largest exchange, has succumbed to bankruptcy and liquidation due to misappropriation of user funds. Even exchanges with decent liquidity often impose hefty listing fees and stringent terms on project teams. In contrast, decentralized exchanges (DEXs) exhibit greater flexibility, employing diverse mechanisms to cater to a variety of user needs. For instance, Pump.fun is renowned for its highly responsive token supply curves, while Curve excels in providing optimal liquidity, not necessarily price discovery sensitivity. These exchanges adopt various models to align with the trading preferences of their distinct target audiences. Inevitably, each approach entails trade-offs, emphasizing certain aspects while compromising on others.

Attempts to create on-chain liquidity

Decentralized exchanges (DEXs) have made significant strides in addressing this trilemma and other on-chain trading challenges through innovation. The long journey begins with a single step, and the first step is to establish on-chain liquidity. Here’s a brief overview of the industry: Uniswap stands as the benchmark in this niche. Its innovative constant product formula marked the dawn of a new era. Prior to Uniswap’s “X*Y=C” curve, DEXs employed order books to settle on-chain trading demands. Subsequent automated market makers (AMMs) followed Uniswap’s pioneering approach, creating liquidity pools. In Uniswap V2, liquidity across different trading pair pools was algorithmically connected. Uniswap V3 introduced concentrated liquidity pools, empowering users to define the price ranges within which they wished to provide liquidity. Uniswap V4 further advanced this by offering customized liquidity pool solutions.

For assets with relatively stable trading prices, the market primarily demands concentrated liquidity provision. Curve Protocol, specializing in stablecoin trading, developed its own supply-based liquidity curve to offer more token liquidity around a predetermined equilibrium point. To address the challenges of constant product pools, Curve Protocol devised a multi-dimensional formula, enabling users to place two or more tokens within a single liquidity pool, thereby sharing liquidity among all tokens in the pool. In practice, centralized exchanges (CEXs) exhibit superior liquidity and pricing efficiency. On-chain pricing systems often lag behind their off-chain CEX counterparts. Hashflow, with the aid of oracles, established professional market maker (PMM) pools to connect on-chain and off-chain liquidity.

However, for small-cap tokens, traditional constant product curves prove costly, and the contradiction between liquidity capital costs becomes more pronounced. Friend.tech designed steeper constant product curves to cater to smaller investors who prioritize price appreciation over ample liquidity. As the token’s value scale increases, investor preferences shift towards liquidity. Inspired by this, Pump.fun utilizes a steep curve when token values are low, but as the value increases, the curve transitions to different slopes or even different curve shapes.

The evolution of liquidity pools

MEV, the race for on-chain liquidity

MEV is another playing field for decentralized exchanges.

Maximal Extractable Value (MEV) represents the profit that miners or validators can capture by leveraging their ability to arbitrarily include, exclude, or re-order transactions within the blocks they generate. It can be viewed as a liquidity cost. In liquidity pools, each exchangeable token (liquidity) is distributed along a price curve, and liquidity is finite within each price range. Those who can interact with liquidity pool contracts earlier gain an advantage by obtaining better prices. In this way, MEV is inherently linked to liquidity issues.

MEV manifests in decentralized exchanges (DEXs) through transaction reordering to capture favorable liquidity. This competition enhances the efficiency of on-chain transactions but also undermines the interests of various parties. To retain as much transaction value as possible within DEXs and distribute it more fully to participants, developers have constructed algorithms and mechanisms at the application layer to intercept the MEV generated by transactions.

Flashbots, a veteran in the MEV management domain, focuses on node revenue distribution. To ensure transparency and efficiency in MEV distribution, they have established an MEV auction system at the node level. Eden Network pursues similar goals. KeeperDAO combines MEV extraction and staking, enabling participants to benefit from MEV while protecting users from its negative impacts. Jito Labs, a liquidity staking project on the Solana network, has also addressed this issue.

As a leading project, Cow Protocol, including UniswapX and 1inch Protocol Fusion, utilize auctioned interaction rights to retain MEV within the transaction process rather than letting this value flow to the node accounting layer. Intercepting MEV protects active traders and AMM liquidity pools, eliminating the previous dilemma of MEV loss due to DEX node bribery.

Fragmented liquidity calls for agents to address the issue

As previously discussed, token liquidity is scattered across various custom pools controlled by different protocols on different blockchains or Layer 2 solutions. Polygon introduced the concept of an aggregation layer to gather liquidity from different layers. Initially, some decentralized exchanges (DEX) aggregators emerged to consolidate liquidity from these diverse pools. However, after accumulating sufficient volume, a more efficient approach is to create platforms that foster competition, such as 1inch and Cow Protocol.

Furthermore, the batch auction mechanism enhances the role of agents. It introduces a novel market mechanism to alleviate liquidity constraints. In essence, traders can place orders at a finite price within a specified time frame. Batch auction smart contracts collect these orders and bundle them into a batch. Subsequently, the smart contracts allow agents to bid on these batches. The agent offering the best price wins the opportunity to settle all potential trades within that batch.

Explanation of the CoW protocol batch auction mechanism

Bulk auction draft from Cow Protocol

Batch auction: the master of DEX development

After years of DEX development, the industry has embraced methods such as batching, auctions, and order matching to optimize trading results for all participants. Specific implementations of auction mechanisms vary, but in general they shift the complexity of optimizing exchange outcomes to professional participants and reallocate the remainder to relatively immature exchangers.

Batch auction diagram

This kind of auction can solve many DEX difficulties in many aspects.

Batch auctions offer far more capabilities than just MEV redistribution, as mentioned in the previous section. Instead of instructions, traders send their intentions to smart contracts. These intentions can persist for several minutes. These intentions are packaged into a batch and offered to a group of competing specialized transaction agents. We understand that the volume of intentions is immense, and liquidity pools come in various forms, making optimization a challenging task. It is more efficient to entrust professionals with specialized tasks.

By sacrificing time efficiency (each trade intention is assumed to last for a few minutes) to maximize value efficiency, batch auctions differentiate themselves from centralized exchanges (CEXs). Batch auctions can keep MEV within the exchange, ultimately benefiting trading participants. Moreover, batch auctions break down cross-chain and on-chain/off-chain liquidity barriers by relaxing time constraints.

What’s more? Barter is back on stage!

Barter Trade Returns to the Spotlight

As the progenitor of all cryptocurrencies, Bitcoin defined itself as a currency. The decentralized market is an emerging domain without clear consensus constraints. Barter is a native trading mode for cryptocurrencies, and it comes naturally, requiring no user education.

Decentralized exchanges (DEXs) are often referred to as “swap” platforms. In their trading model, there is no predetermined universal equivalent role. Traders do not have to use fiat currencies or stablecoins as intermediaries. At the liquidity pool level, any trading pair is allowed. Traders can use any token they prefer to exchange for other tokens, bearing the cost of low liquidity efficiency.

However, relying solely on liquidity pools for barter trading has significant limitations. There are not enough pairs for all types of barter transactions. Due to the structure of liquidity pools, liquidity deployment takes a long time, and it is difficult to find equilibrium prices. Therefore, liquidity must be deployed within a wider price range, leading to scarcity compared to the limited-time demand for intentions. This is where intentions and batch auctions come into play.

Suppose there are multiple potential trade intentions that can meet each other’s needs, supplemented by liquidity from a pool. In this case, barter trading will return to the market in a more efficient state. As the scalability of Web3 infrastructure improves and more commodities and financial instruments join Web3, batch auction smart contracts will capture thousands or even millions of trade intentions per second. Any token can serve as a means to settle other tokens. We will break free from the liquidity constraints imposed by the US dollar in the universal context.

Bulk Auctions: The Key to On-Chain Barter

The resurgence of barter represents a revival, not an innovation, responding to market demands.

Historically, when currencies were invented, traders struggled to find direct barter opportunities that met their immediate needs. Therefore, they exchanged goods for a universal equivalent (currency) and then purchased what they truly desired in another transaction. Once this exchange pattern gained widespread acceptance, it forced genuine barter demands to be divided into at least two steps, rendering direct barter markets obsolete.

Today, on-chain barter demands exist in the form of short-term intentions. Batch auction smart contracts collect these intentions. Anyone, whether human or AI agent, can fulfill the entire trading demand by offering the most favorable bid. If intentions match, there is no need for dollar-pegged stablecoins. Tokens retain their utility and share liquidity as they once did. This matching of barter demands is based on global markets and enhanced information matching capabilities, extending from the traditional barter culture of cryptocurrencies.

In the short term, the existence of intention time horizons enables arbitrageurs to move liquidity across chains, from off-chain to on-chain. For instance, an algorithm that discovers price discrepancies between different chains or between DEXs and CEXs could buy at a lower price and sell at a higher price within the specified time frame. It might need to employ financial instruments to hedge market risks to achieve a risk-free state. However, in the future, when on-chain, off-chain, and cross-chain trades can be executed simultaneously, all trades can be fulfilled simultaneously. This can eliminate risk costs and provide traders with the best possible experience.

Why barter under batch auctions is a milestone in the DEX era

The reason is simple. If we look back at the history of currency, the right to mint coins was originally private. According to “Debt: The First 5,000 Years,” debt could be personal. Even in modern times, as detailed in “A Monetary History of the United States, 1867-1960,” private individuals could once mint silver coins. However, today, all credit is issued by the Federal Reserve. Even Bitcoin is priced in US dollars, a misfortune of our time. The US dollar has overshadowed the brilliance of cryptocurrencies. Barter trading offers an opportunity to reclaim this position, hence the significance of the barter revival era.

The development of decentralized exchanges (DEXs) gives us confidence that we can eventually surpass centralized exchanges (CEXs). Last DeFi summer, it was widely believed that DEXs would surpass CEXs in due course. How many people still hold this belief today? If we examine the development of DEXs, the introduction of batch auctions is no coincidence. It is a well-considered step towards solving the liquidity problem and a phased result of the continuous technological iteration of DEXs. DEXs have evolved from simply having liquidity pools to becoming a comprehensive liquidity system with different participant roles, specialized components, and permissionless composability. This progress was achieved through the efforts of our predecessors. Relaxing time constraints and creating conditions for differentiation from CEXs has opened up more possibilities. It has even restored my confidence in DEXs surpassing CEXs.

A business cycle has passed, and while the DeFi giants have remained the same on the surface, they have undergone a metamorphosis within. Batch auctions are a significant milestone, just as important as the invention of liquidity pools. I believe they can make the dream of DEXs surpassing CEXs a reality. When barter once again becomes the primary trading mode, we can regain control of our market rhythm.

Afterword

In my discussions with numerous industry experts about the future, I’ve noticed a widespread sense of uncertainty, stemming from a general disregard for technological advancements, which has dampened overall confidence.

I recall a conversation with a friend in late 2018 or early 2019 over hotpot in Chengdu, where we enthusiastically discussed the promising future of DeFi and Ethereum. Despite ETH’s price being below $90 at the time, his eyes sparkled with excitement.

Think about it, when did we, as an industry, reach a point where we rely on speculators’ wallets to define our path?

Decentralized exchanges (DEXs) are merely a small component of the vast DeFi landscape. Upon closer examination, we can witness significant and thrilling advancements unfolding in DeFi and beyond. As long as technological progress continues unabated, what more is there to fear? Our aspirations will undoubtedly materialize.

To all industry pioneers forging ahead, I offer a line from an ancient Chinese poem: “Do not fret when you feel alone, for your brilliance shall be recognized by the world.”

Thanks to the help of @Jialin, and the encouragement of @NewMingshiS, @0xNought, the observer completed the last observation record of this trip on the beach of Amed Bay in Bali.

References:

1.Debt: The First 5000 Years

2.Money: The Unauthorized Biography

3.The Ascent of Money: A Financial History of the World

4.A History of Money: From Ancient Times to Present Day

5.The capital

6.The Future of Stablecoin Design

https://www.fixing.finance/report/the-future-of-stablecoin-design

7.Uniswap Labs and Across Propose Standard for Cross-chain Intents

https://blog.uniswap.org/uniswap-labs-and-across-propose-standard-for-cross-chain-intents

8.Understanding Batch Auctions

https://blog.cow.fi/understanding-batch-auctions-89f0f85e6c49#:~:text=A batch auction is a,rules that prevent MEV attacks.

9.Uniswap v2 Overview

https://blog.uniswap.org/uniswap-v2

10.Introducing Uniswap v3

https://blog.uniswap.org/uniswap-v3

11.Aggregated Blockchains: A New Thesis

https://polygon.technology/blog/aggregated-blockchains-a-new-thesis

12.A deep dive into 1inch Fusion

https://blog.1inch.io/a-deep-dive-into-1inch-fusion/

13.Priority Is All You Need

https://www.paradigm.xyz/2024/06/priority-is-all-you-need

14.Quantifying Price Improvement in Order Flow Auctions

https://blog.uniswap.org/UniswapX_PI.pdf

statement:

1. This article is reproduced from [AC Capital Research )], the original title “Bartering on the chain: Let’s get back to the rhythm of encryption”, the copyright belongs to the original author [Armonio, AC capital], if you have any objection to the reprint, please contact Gate Learn Team, the team will handle it as soon as possible according to relevant procedures.

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