Seamless DeFi Liquidity : Enabling cross-chain infrastructure through Dfyn & Router
- Liquidity is all-important in DeFi. Liquidity is getting fragmented across multiple Layer-1 and Layer-2 chains as Ethereum goes through growing pains. Even after the imminent protocol upgrades, liquidity in the blockchain space will continue to remain fragmented across multiple chains, as transaction throughputs required are multiples of what even ETH 2.0 can deliver.
- In this scenario, cross-chain infrastructure that connects liquidity across chains assumes importance.
- Router Protocol, in conjunction with Dfyn, is building critical cross-chain infrastructure to enable liquidity to move easily between chains.
- Router is a liquidity super mesh, and Dfyn is a multi-chain AMM
While the crypto industry is often perceived as a set of simple, straightforward ideas, the new financial market that we all know today is anything but simple. Scratching the surface even slightly reveals a level of depth and complexity that is possibly not seen even on Wall Street. All of that became even more complex with the advent of the DeFi market. The concept of programmable smart contracts on highly promising blockchain networks such as Ethereum opened up doors to a plethora of projects with the potential to revolutionize traditional finance or TradFi. On the flip side, it has also unlocked a nasty Pandora’s box brimming with issues that the industry has not been able to place a lid on.
The concept of programmable money is widely seen as a paradigm shift and with good reason. Before programmable money was a thing, people with ideas related to products involving money would give up early because any such development implied the need for licenses and certificates, which were very often a laborious process that killed most entrepreneurial zeal. Decentralized networks like Ethereum, while eliminating the need for financial intermediaries, also made the need for such licenses and real-world paper contracts less relevant, if not completely obsolete. However, the omission of intermediaries and centralized regulatory bodies in the DeFi world meant that a smart contract must always be present on the other side of any transaction to honor the trade. However, the mere presence of smart contracts is just a necessary condition for trading in the DeFi sector, not a sufficient one.
The need for liquidity
For a protocol to work in the DeFi market, it needs sufficient liquidity to support trades. The amount of liquidity in a DeFi protocol is also referred to as the total value locked (TVL). A high TVL ensures that users can trade assets within a protocol with a certain amount of confidence that they will be able to enter & exit their trades as they please. With ample money running through the protocol, there is never too much friction between buyers and sellers, resulting in a stable and smooth ecosystem that rewards long-term participants.
Until last year, the liquidity model adopted by the most prominent DeFi protocols on the market, such as Uniswap and Compound, worked relatively well. With only a few hundred million dollars locked in the entire Ethereum network and a relatively small number of users, there never was any chance for friction to be highlighted. Traders would expect and accept the inefficiency of markets as a given. However, the DeFi Summer of 2020 drastically impacted the almost utopian equilibrium that existed in the market. The total value locked across liquidity pools on Ethereum increased from $914 million in May last year to over $75 billion in May 2021 and is expected to increase even further as the year progresses.
The problem of putting liquidity to good use
The largest driver for the TVL in DeFi protocols is actually investments chasing yields in a low macro environment, as investors seek to move towards passive income and away from idle capital. And while $75 billion might sound like an absurd amount of money, only a small fraction of that is actually being used to facilitate trades. There is a high degree of capital inefficiency in DeFi, which protocols are trying to address in their own way. Paradoxically there is also a high degree of leverage in the system, thanks to DeFi’s lego-like composability, which creates a completely new set of ‘unknown unknowns’
This model can be best explained by taking the example of wBTC. The protocol enables users to lock their Bitcoins (BTC) and open up positions in the DeFi market by “wrapping” the BTC and launching it on Ethereum as wBTC. From there, users can earn additional yield by staking their wBTC in various lending and borrowing protocols — effectively increasing their BTC positions along the way. The success of this model has led to the creation of various other wrapping protocols such as RenBTC and serves as an example that showcases the power of liquidity flows.
Unfortunately, even this rather successful model had its pitfalls. The rapid growth of the DeFi industry, coupled with the bull market that propelled Ethereum’s price to all-time highs, has rendered the network inaccessible to many. The cost of performing transactions over the Ethereum network is typically between 30 to 50 times higher now than they were a year ago. And, while it benefits miners by allowing them to make unprecedented profits, it makes it prohibitively expensive for all but a small group of high-net-worth market participants to use.
For example, swapping two assets on Uniswap through its AMM currently costs around $100. This, believe used to be a simple operation that mostly cost less than $5 in fees less than a year ago. As Ethereum’s price continues to skyrocket, so does its gas fees. The increase in congestion compounds the gas fees even further. This serves as a deterrent to smaller (retail) network participants looking to put a few hundred dollars worth of cryptocurrencies into a liquidity pool, leaving most of the liquidity provision to big bag holders and whales, further concentrating the power on the network into the hands of a few players.
The good news is that the dynamism of the crypto market quickly led to a solution to this problem. The bad news is that this solution, in turn, created a whole new set of problems.
The problem of liquidity fragmentation in the DeFi market
Faced with increasing network congestion, the market quickly adopted scaling solutions, which are the various Layer-1 and Layer-2 protocols. As their name suggests, these protocols either add another layer of transactions on top of Ethereum, or form entirely new blockchains.
In recent times, multiple such approaches have emerged, including BSC (Binance), Solana, Avalanche, HECO (Huobi), Algorand, Arbitrum, and Polygon, to name a few.
More Layer-1 and Layer-2 solutions like these are popping up every day, with each one offering a unique set of features and benefits. One key benefit of such solutions is that they offer transactions for almost negligible fees, and are mostly much faster than Ethereum. For example, the transaction costs in the Polygon network are less than a fraction of a cent. The same transaction would have cost over 100,000 times on the Ethereum network. Of course, the hard constraints here are the traded-offs between three axes of the trilemma — between scalability, security and decentralization.
Regardless, some of these platforms have seen significant adoption. Witness for instance, Polygon’s growth over the past few months, coinciding with the rise of DeFi and a rise in ETH gas costs. Real cost savings accrue to those who are willing to take the leap from L1 to L2. Consider for instance the following figure. In just its first week, DFYN witnessed 400,000 swaps on its platform. If all this had happened on Uniswap, even assuming a conservative gas fees of 30 dollars, the costs paid by users to the Eth miners would have been 12 million dollars.
These are real savings. Now imagine the annual savings on a platform like DFYN. If you now consider that there are other platforms on Polygon that offer similar savings, and now also factor in the emergence of a few other chains in the future which will deliver similar savings with a variety of dapps running on top of them; The total dollar saved quickly begins to add up, potentially running into double digit billions annually. And all this will happen with a good chunk of growth in activity still continuing to happen on the mothership, the L1 Ethereum chain.
While the success of these protocols is a testament to the hard work and innovation of the crypto community, it has given rise to another problem — fragmentation. Until the emergence of all these protocols, all of the liquidity of the DeFi market was concentrated in Ethereum. Now it is fragmented across dozens of protocols, with more emerging protocols and bridges threatening to fragment it even further.
Bridging is great, but ultimately only a partial solution to the problem of liquidity fragmentation
The self-evident and almost natural solution to the problem of liquidity fragmentation is cross-chain bridges.
The team behind Router Protocol realized early on that the infrastructure used to create bridges between isolated blockchains could drastically increase their efficiency. As liquidity fragments between multiple isolated pools, it loses its efficiency and velocity and becomes harder and harder to utilize. Conversely, anything that enables liquidity to flow seamlessly between blockchains can increase capital efficiency in the system.
While concentrated liquidity is one measure of capital efficiency, cross-chain infrastructure such as Router Protocol are more concerned with another measure of liquidity — aggregated liquidity.
Router Protocol aims to build liquidity bridges, and eventually, a liquidity super mesh spanning multiple blockchains, allowing easy cross-chain asset transfers. XCLP, Router’s native cross-chain liquidity protocol, enables users to migrate assets from one chain to another quickly and cheaply.
For example, using Matic’s PoS bridge to transfer USDC from the Matic Network to Ethereum takes between 3 and 4 hours.
Router’s XCLP can settle the same transfer of USDC from the Matic Network to Ethereum in less than 1 minute, as is demonstrated in Router’s Testnet, where users can swap assets between Ethereum (Kovan), Matic, BSC, HECO, and Avalanche.
Router is therefore laying out cross-chain infrastructure in the form of a liquidity super mesh. So far, the protocol has successfully demonstrated inter-blockchain transfer of various stablecoins on its testnet. The next step in Router’s development is to demonstrate the ability to transfer any number of ERC-20 compatible assets and introduce cross-chain swaps. Cross-chain swaps along with smart-order routing features that are commonplace in TradFi exchanges enable users to get trade effectively across different blockchains. Think 1inch-style aggregated trading capabilities, but across blockchains.
To understand how Router protocol works, one needs to understand the basics of cross-chain bridges. A bridge is nothing more than a contract or a set of contracts capable of locking assets on one blockchain and releasing them on another blockchain. There are two crucial parts to this equation: the availability of assets in both blockchains to allow for asset transfer and the availability to communicate securely between the two blockchains.
Recent developments in the crypto industry have significantly resolved the communication issues that existed earlier. Communication infrastructure provided by various open-source protocols has solved this for most projects building cross-chain bridges, including Router. Router Protocol is working on its own custom inter-blockchain communication platform (XCLP — Cross-Chain Liquidity Protocol), to significantly improve existing cross-chain communication frameworks, and also to ensure that protocol validators are relaying the inter-blockchain communication messages in a timely and incentivized manner.
The problem of asset availability, however, still needs work.
To ensure ample liquidity on both blockchains on either side of a transfer operation, there must be a mechanism that ensures liquidity providers are incentivized to provide liquidity. Solving this problem requires taking inspiration from some of the largest liquidity hubs in the DeFi market. Automated market makers (AMMs) such as Uniswap have access to billions in liquidity because they reward their users with liquidity provider fees. Sushiswap, another major AMM player on the market, also has a generous mechanism rewarding those that provide liquidity to the protocol.
If a protocol fails to incentivize its liquidity providers properly, they are, without exception, quick to leave for a competing network that offers better conditions.
Router and Dfyn working in concert to solve the cross-chain liquidity problem
Imagine the various blockchains as various cities spread geographically on a map. In the current state of the blockchain world, there are very few roads, bridges, tunnels, and other forms of infrastructure connecting these cities, and the venues that exist within them, such as exchanges and lending platforms. The few that exist are cumbersome, inefficient, expensive, and unreliable.
This ‘medieval’ state of the blockchain world will, however, not last; A number of projects are working on building bridging infrastructure. Router, however, has one key differentiation. And that differentiation is the Dfyn multichain AMM
Dfyn.network is a multichain AMM protocol, currently launched on the Polygon Network. The initial version is basically a turbo-charged Uniswap (but without the expensive ETH fees or the congestion) deployed on an L2 blockchain with instant, gasless transactions. The eventual roadmap, to be released soon, envisages significant enhancements to existing generation-1 AMM models. Dfyn aims to be a truly multichain AMM, with nodes across chains aggregating liquidity, and each node plugging into Router’s liquidity super mesh to facilitate seamless transfer of liquidity between the chains. The current DFYN node on Polygon has become fully functional and has accrued almost $250 million in liquidity, reaching daily trading volumes of over $75 million within six days of its full-fledged main net launch.
A little bit of DFYN’s history might be in order here. It was the first AMM to launch on Matic, as Polygon was formerly called. However, the key issue here was still the crosschain bridging infra, and to solve this issue, we shifted our attention to Router and have reached a stage where we are a few weeks away from the Router mainnet.
In the meantime, a small but active community continued to gather around Dfyn and steadily increased the DEX’s popularity and efficiency. A few key factors helped; Apart from the smooth, Uniswap style user experience, one key draw was the instant, gasless transactions. Even today, to the best of our knowledge, DFYN is the only DEX on any chain (not just Polygon) offering gasless transactions, and we were undoubtedly the first to do so. Users do not need to hold any Matic gas at all, and they will not need to hold the tokens of any L2 chain on which DFYN will open up a node in. DFYN achieves this by integrating a relayer for meta transactions. You can read more about how Dfyn achieves completely gasless transactions here.
The Matic Network has since flourished with many projects coming on board, and the MATIC token has increased in value over 25x since Dfyn launched. The huge success Matic has seen, and the steady rise in Dfyn’s popularity led to a demand from the community for a token launch. This turned out to be a perfect solution to Router’s impending liquidity incentive problem for its bridges, which is why we decided to launch the DFYN token at the beginning of May. Since the IDO of DFYN on Polkastarter, we have successfully established an Incentivized Liquidity Mining program on the Dfyn Exchange to reward liquidity providers with DFYN tokens.
The Dfyn.network AMM will soon expand to other chains like BSC and Huobi. Subsequently, there are plans to launch the Dfyn network on Algorand and Avalanche. Once we have Dfyn nodes running on multiple blockchains, Dfyn will utilize Router’s cross-chain bridges to seamlessly transfer and trade assets across different blockchains. Router’s mainnet launch is also expected in the next few weeks.
The DFYN token is a deflationary community governance token with a supply capped at 250 million tokens. It will be used to aggregate liquidity across multiple Layer-1 and Layer-2 blockchain solutions by leveraging Router’s cross-chain bridges and, in turn, used to incentivize the Router community to provide liquidity to the network.
Extending our geographic connectivity analogy
Once we have a way to port liquidity across chains and onboard and off-board liquidity within each chain, the possibilities are truly endless. Everything that is currently on Ethereum, or Polygon, or BSC will now get repurposed to work seamlessly across chains. For instance, if you receive a word document, you can open it on a Macbook or a Windows PC, or a Linux machine. In the same way, over the next few years, we will see a reversion of the fat protocol thesis, as the application layer gains ascendancy. The specifics of the underlying blockchain, the protocol layer, will recede into the depths of the black box, and you are going to deal increasingly with the application layer. In the early days of Web 1.0, companies had powerful Sun Solaris and IBM servers on-premise, but now almost everything is in the cloud with AWS or Azure, and all you deal with is a screen on a laptop or a mobile device. DeFi will also become truly chain agnostic, with cross-chain plumbing like Router bridging these chains and apps like DFYN and their successive versions over the years, building various interfaces for trading, lending, swapping, etc.
With DFYN and Router, we are therefore creating a set of core infrastructure building blocks, upon which developers can further iterate and build advanced dapps for trading, cross-chain lending, and so on. In addition to the obvious use case of something like a 1inch spanning chains, this could potentially include an Aave or Compound across chains, or even a Polkastarter across chains, a platform where creators can launch IDOs simultaneously on multiple chains with various communities across chains contributing and competing for liquidity.
It is a multi-blockchain world where there will soon be abundant connectivity and liquidity flows. In such a world, the possibilities are truly endless.
Stay tuned for more technical details about Dfyn and Router.
Dfyn is a multi-chain AMM DEX currently functional on the Polygon network. Dfyn nodes on various chains act as liquidity entry and exit points into the cross-chain liquidity super mesh that is being enabled by Router Protocol.
Telegram Announcement : https://t.me/dfynofficial
About Router Protocol
Router Protocol is building a suite of cross-chain liquidity infra primitives that aims to seamlessly provide bridging infrastructure between current and emerging Layer 1 and Layer 2 blockchain solutions.
Telegram announcements: https://t.me/router_ann