Decentralized finance (DeFi) is the fastest-growing sector within the cryptocurrency markets. With promises of an open-source, permissionless, and consumer-centric financial ecosystem, DeFi is set to change the trajectory of institutional finance. As of December 2021, DeFi-based protocols had US$ 251 billion in total value locked (TVL), with Ethereum dominating the market share, followed by Terra and Binance Smart Chain (BSC).
- Most decentralized exchanges (DEXs) operate as order books, similar to centralized exchanges (CEXs), where users buy and sell orders at their preferred prices. The major difference between CEXs and order books DEXs is that the latter holds the assets in users’ wallets instead of exchange wallets. Order books DEXs can be off-chain or on-chain, depending on their architectures.
- However, without sufficient liquidity to back the trading volumes, a DEX can become unstable and subject to price swings and slippages. This forces users to leverage multiple DeFi protocols on different chains to swap tokens. Besides the long waiting times, high transaction costs, and slippages that users face, there is also the possibility that liquidity providers (LPs) in a given pool will experience impermanent loss.
- The liquidity problem also extends to automated market makers (AMMs)-based DEXs. In an AMM-driven DEX, buyers and sellers do not transact directly but use a collective liquidity pool (LP) and algorithmic protocols. However, rather than having a single pool that provides liquidity for an asset to connected layer-1 chains, AMMs use LPs from2 a single network.
- Analog enables a timed, multi-chain order book DEX/AMM where bids are partially-filled trustlessly across different networks of LPs. This solves the problem of liquidity fragmentation—without any centralized bridges or wrapped assets— and guarantees finality on the source chain.
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