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The DEX Dilemma – Governance v Liquidity

Last week DDEX – one the biggest relayers built on 0x – announced that they plan to fork off the 0x protocol and move to a newer protocol called ‘Hydro.’ DDEX’s decision to move away from 0x might have come across as a surprise to many as DDEX is the biggest relayer in terms of trading volume, but the prolonged lack of liquidity on DEXs is what has caused DDEX to move to a competing protocol. DDEX’s claims the protocol is focused on bringing more liquidity to DEXs.

Before we evaluate the merit of DDEX’s decision to leave the 0x ecosystem and trade the associated network effects for a relatively new and untested protocol, we need to take a closer look at the technical and business challenges being faced by 0x based relayers or decentralized exchanges in general. A year ago, DEXs were pretty much everyone’s darling in the crypto space as they were widely believed to be the ultimate solution for trading crypto assets in a non-custodial and trustless way. Before the advent of DEXs, crypto assets trading was predominantly facilitated exclusively through centralized exchanges that controlled their users’ private keys. Although exchange of crypto assets between users is a critical component of the decentralized ecosystem, the fact that users have to trust centralized exchanges goes against the very ethos of the blockchain revolution – the trust minimization aspect of it. Moreover, centralized exchanges present a powerful attack surface for hackers to try and steal users’ funds. In spite of these critical flaws with centralized exchanges, earlier iterations of DEXs such as EtherDelta failed to attract users from centralized exchanges to DEXs due to their undercooked UI/UX, lack of speed and expensive trading process.

The 0x team came up with the idea of building a protocol on top of which you could build relayers that take away the slow and expensive process of order hosting by having off-chain order books, without giving away the transparency and trust minimization of on-chain trade execution. While there were many problems such as order collision and miner frontrunning that needed addressing, 0x based relayers were a significant upgrade to the earlier iterations of DEXs. Fast forward 12 months, the UI/UX of relayers has improved significantly and yet they have not kept pace with everyone’s expectations of hockey stick growth, like with many other projects in crypto, where the opportunity gets overestimated in the short run and underestimated in the long run. Centralized exchanges still have a bulk of the trading volumes, with the top 10 exchanges accounting for close to $10 billion in trading volumes in the last 24 hours as of printing, while comparable top 10 DEX volumes are south of $5 million.

One of the biggest reasons why DEXs have been struggling in comparison to their centralized counterparts is the lack of adequate liquidity, which in turn stems from sub-par speed and efficiency versus centralized exchanges. Centralized exchanges offer instantaneous trade finality, whereas DEXs need 10-12 confirmations on the ETH blockchain. This tweetstorm by Antonio@DyDx perfectly captures the technical impediments that currently plague DEXs.

The key reason that has prompted the DDEX move to Hydro is the need to drive liquidity. HOT tokens (Hydro tokens) incentivize participation in liquidity pools, reward market makers for providing liquidity and have in-built penalty mechanisms to punish frontrunners. According to DDEX, Hydro exclusively prioritizes liquidity over everything else, while 0x is dedicating its developer resources towards 0x Instant, NFTs, modularizing smart contracts for easy transition for users during protocol upgrades and building a robust framework for protocol governance. Governance has become a priority focus area for 0x as its native token’s value is now predominantly dependent on what features the token can govern. Will Warren in his recent talk at ETH DevCon presented more details on how the protocol governance will be handed over to the community. There’s ongoing debate around whether to build first and govern later or vice-versa or focus on both simultaneously. DDEX’s departure implies that they believe a different approach with a different order of prioritization is needed to tackle the problems pertaining to poor liquidity on relayers.

However, as the crypto cliche goes, these are early days with DEXs’ as well, and 0x has, in addition to a great team, an entrenched network of developers, some serious backers and most importantly, access to some really powerful networks and the associated mindspace with in the SFO crypto ecosystem. Proof of this is the recent announcement from Coinbase Earn, where one can earn 0x by simply learning about cryptocurrencies. As we opined earlier in a piece on crypto market dynamics, 0x also has some ‘high-ground’ advantages as the incumbent, including the ability to rapidly incorporate new features from a competitor that is gaining traction can be easily copied. While the promise of liquidity will definitely attract some initial interest, unless Hydro comes up with a solution that is transformationally compelling, it will struggle to attract the critical momentum of developers that it needs to grow into a viable 0x alternative.

Meanwhile in Crypto Wonderland….

“Coinbase Moves $5 Billion” Major cryptocurrency exchange and wallet Coinbase recently made what it claims is the largest transfer of crypto on record. 5 percent of all Bitcoin (BTC), 8 percent of all Ethereum (ETH), and 25 percent of all Litecoin (LTC), along with “many other assets” were moved to new cold storage infrastructure in what the firm “believe[s] is the largest crypto migration on record”.

“Bill Proposes Securities Classification to Exclude Digital Assets” Two United States congressmen have introduced a bill in the House of Representatives that would exclude digital assets from being classified as securities. The “Token Taxonomy Act of 2018”, introduced by Warren Davidson ® and Darren Soto (D), seeks to amend the Securities Acts of 1933 and 1934. The document further defines that the Secretary of the Treasury should issue regulations providing information for returns on transactions in digital currency for which gain or loss is recognized.

“BTC Performance Mirrors 2011, 2013” A former AQR Capital Management executive gave crypto markets’ 2018 performance a “B+ grade” in a Bloomberg opinion piece. Aaron Brown, AQR’s former Chief Risk Manager, pointed out that Bitcoin’s 80% fall from its $20,000 one year ago mirrored peaks and falls in previous years, namely in 2011 and 2013. Brown outlined the fact that Bitcoin’s decline this year has been relatively milder than the rapid drop after its peak in 2011 but sharper than its peak in 2013.

“McAfee Labs Report Rise in Cryptojacking”Cryptojacking malware activity rose by over 4,000% in 2018, according to a new quarterly report published by cyber security firm McAfee Labs. The McAfee statistic of over 4,000% specifically refers to total instances of a cryptojacking malware, referred to in the study as “coin miner”. The report extends to a range of new crypto mining malware threat vectors, which notably include a spike in new malware targeting Internet of Things (IoT) devices.

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