Arming the Rebels against Exchanges

Table of Contents

1. Introduction

2. 🌊 The Role of CEXs

3. 🧮 AMMs and Pricing Models

4. 🔫 The Shopify for DEXs (Arming the Rebels)

5. 🤔 What’s the catch?

6. 💪 Take the power in your own hands

7. Conclusion

_{Disclosure: This piece is sponsored by Native. We only work with projects we believe in and use ourselves. This is not financial advice, do your own research.}

Introduction

Centralized Exchanges unquestionably reign as the titans of the crypto industry. They serve as the most dominant piece of infrastructure in the ecosystem, easily the number one source of liquidity for the entire industry and acting as the single gateway through which you can enter and exit the space.

However, they are not without their flaws. Their massive revenues are drawn from the pockets of smaller players, and our reliance on them grants them incredibly strong market power.

Decentralized exchanges present a captivating alternative, offering a balance of power more aligned with the ethos of crypto. But there are no free lunches; this increased control comes at a different expense. In this case, that cost is capital efficiency—liquidity becomes fragmented across the ecosystem, slippage is inevitable, and providing liquidity demands constant vigilance to avoid impermanent loss.

Decentralization is not binary; it exists on a spectrum. Middle grounds may not be a thrilling topic of discussion, but within that vast unexplored territory lies a range of inventive solutions. To the chagrin of staunch ideologues, nuance and education become increasingly important here.

Venturing into this liminal space, Native returns with a unique solution. It all starts with the simple question: "How can we combine the benefits of both centralized exchanges and decentralized exchanges?"

Their response? A hybrid model that combines off-chain pricing with on-chain settlement and self-custody. This method more efficiently aligns the incentives of projects, market makers, and traders. To understand how, let's first examine the role of each of these participants. If you're already familiar with this topic, feel free to jump to the "Shopify for DEXs" section.

🌊 The Role of CEXs

If you want to join the crypto circus, centralized exchanges are the gateway you must pass through. Exchanges have been crucial for the adoption of cryptocurrency and blockchains; without them, we'd hardly have an industry.

They embody all the benefits of centralization:

• Unrivaled financial and human capital

• Capital-efficiency

  • Deeper liquidity, better pricing

• More user-friendly

  • Technical knowledge not required, complexity is abstracted away

  • Intuitive UI

• Top-notch marketing exposure in the industry

• Strong connections in the industry

• Compliance with regulatory bodies (mostly)

For projects, a close relationship with a major exchange will put you on the map, or even on the throne. They provide the ultimate form of distribution.

However, this Faustian bargain for founders comes at a significant cost to their projects:

• Six-figure listing fees

• Monthly fees to maintain liquidity

• Value-extractive trading fees

• Loss of control over tokens (not your keys, not your coins)

Some founders see this as a necessary evil, while others view it as unthinkable. For the latter, decentralized exchanges remain an alternative option.

🧮 AMMs and Pricing Models

Decentralized exchanges are arguably the biggest success story in demonstrating a practical use-case for smart contracts, having hit their stride during DeFi Summer 2020. Not only are they a viable alternative to centralized exchanges, but they also function as crucial infrastructure in their own right – the 12-month DEX volume currently amounts to $907 billion.

Each DEX comes with its own tradeoffs and weaknesses, subject to the choice of pricing models an Automated Market Maker (AMM) uses. However, the pace of innovation and abundant competition is encouraging, providing many different options to users and projects based on their needs.

Some of the most popular AMM pricing models:

1. Constant Product formula (Uniswap v2)

   1. The OG x*y = k formula. For large swaps, slippage is significant.  

2. Concentrated Liquidity (Uniswap v3)

   1. Liquidity is concentrated over custom ranges instead of being evenly distributed across the price curve, leading to greater capital efficiency.

3. Liquidity Bootstrapping Pools (Balancer v2)

   1. Pools are launched with a project token and blue-chip collateral. Initially, the weighting is skewed towards the project token and dynamically adjusted over time, enabling Fair Launch Auctions and a more gradual price discovery process.

4. StableSwap Invariant (Curve)

   1. Invariant of constant product formula ideal for closely pegged assets (e.g. stablecoins). Highly efficient with minimal slippage.

5. [REDACTED]

   1. HINT: It’s the key to Native’s solution… (read on to find out 😉).

The technical innovations behind these solutions are very exciting, but Decentralized Exchanges are still in their infancy, and trading volume of Centralized Exchanges are 7-10 times higher. Here’s a visualization for comparison:

Liquidity is king. If you’re a whale, capital efficiency is the key to avoid getting cucked into oblivion through slippage like this individual:

If only there were a middle ground…

Private Market Makers (PMMs)

1. Entities that fulfil buy and sell orders through APIs.

This PMM approach combines the best of both worlds.

Off-Chain Liquidity + On-Chain Settlement

By partnering with PMMs on the back-end (who account for over 30% of daily crypto trading volume), Native’s team of quants exploit this flexibility for greater capital efficiency and pricing. A Request for Quote (RFQ) is sent to their PMM partners, and if their price is more competitive the swap will be routed via them. If not, swaps will be routed via a cheaper option, like a DEX. Users sign their order and transact peer-to-peer, retaining custody of their assets throughout.

In many ways this is similar to the promise of Layer 2s - scaling transactions on a separate blockchain, but inheriting security by posting finalized proofs back to Ethereum.

🛒 The Shopify for DEXs

⚔️ Arming the Rebels 

Native describes itself as “the invisible DEX layer for crypto”, providing the infrastructure for project founders to create their own DEX in just 5 minutes.

This playbook is a proven one, reminiscent of Shopify’s strategy to compete within the e-commerce space. As a monopoly, merchants are at the mercy of Amazon’s marketplace. Your fate as a seller is determined by Amazon’s search engine and your page ranking within your category.

Shopify found success by taking a different approach - arming the rebels. They built a platform to make commerce available for everyone, empowering SMEs to become more competitive. Their cloud platform provided all the tools needed to build an online shopfront quickly and affordably, fulfilling all front and back office needs in one app.

Native is doing the same for crypto founders.

Instead of listing on an exchange and striking a deal with the devil (which is out of reach for new projects anyway), founders can leverage Native to create their own DEX… for free.

The Benefits:

• Quick set-up (5 minutes)

• Completely free (no fees)

  • Native provides the liquidity, not you

• Capital-efficient

  • Native’s PMM network provides CEX-level liquidity and pricing

• Control

  • Retain your own tokens

  • Choose any desired trading pairs

  • Set your own swap fees

  • Users self-custody their assets, settling transactions on-chain

• Unlock new revenue streams

  • Swap fees go to token issuers

• Composability

  • DEX serves as a widget, embeddable in your website or dApp

  • Future possibilities: Discord widget, browser widget

• Enhanced community engagement

  • Greater control for the project = greater community influence

  • New revenue can fund development, growth, piñatas… anything really. DAOs could vote on allocation.

  • Reduced swap fees for the community minimizes value leakage

We decided to try it for ourselves - visit the Hunting Alpha DEX to trade through Hunting Alpha.

🤔 What’s the catch?

It’s a reasonable question, and likely the first one that comes to mind. This was indeed a frequent query regarding Native’s proposal for Venus to deploy its own in-app DEX (rather than PancakeSwap). Here are the responses from the Native team:

The Snapshot Vote passed with 100% in favor.

💪 Take the power in your own hands

Native’s “invisible DEX layer” product offers a bold solution to a real problem. Liquidity is like oxygen to a young protocol, and the long-tail of projects facing this issue are underserved. At the very least, it provides a third option for founders to explore, making the industry as a whole more competitive.

The crypto industry remains in its embryonic stage, and solving infrastructure challenges is a prerequisite for achieving mass-adoption. This was central to Nomad Capital’s investment thesis when they recently led Native’s $2m seed round:

Our friends at Arbela address this Middleware problem-space in their latest report. For a more unbiased perspective, check out their recent Analyst Report on Native.

Conclusion

My favorite aspect of Native’s solution is incredibly simple - it aligns incentives for all parties involved.

A few years ago I interned at Mitsui, one of Japan’s sōgō shōshas (very large, very old multinational companies). Mitsui was founded in 1673, during the Edo period.

I learned a valuable lesson there that has stuck with me ever since. One day a director gave us a presentation on the company’s values. Its core value, the secret to it enduring 350-year endurance, was this: the three-way win.

Win-win-win: good for you, good for me, good for everybody.

I always search for this basic dynamic in projects, and Native is a prime example.

Good for you (founder): Reasons outlined above.

Good for me (Native): Earns revenue from private market makers.

Good for everyone (PMMs): Tap into a new market (the long-tail of crypto projects) and still earn a profitable spread.

Sounds like a three-way win to me.

Until next time,

Sending Alpha 🥂

_{Hunting Alpha is an exclusive community for the next generation of alpha hunters. Check out what we’re building here.}