When Uniswap popularized decentralized exchanges on the Ethereum network, it was a groundbreaking development. DEXs allow users to become liquidity providers for token pair swaps.
DEX liquidity is as high as there is interest in escrow assets for specific token pairs. It is the job of DEX aggregators to solve this problem by optimally merging swap orders from multiple DEXs.
Why is liquidity important?
In short, liquidity is money that allows market participants to execute trades and deals quickly. The more liquidity there is, the faster and more dynamic a marketplace is. When liquidity becomes scarce, sellers can find it difficult to find buyers and this can affect the prices of assets in the market.
For this reason, traditional markets for stocks, currencies and commodities have specialized institutions, called market makers, to stimulate trading. These institutions do not exist in DEX.
The downside of DEXs
DEXs do not rely on market maker intervention. An exchange of one token for another is fully automated through the use of smart contracts. For example, at Uniswap, smart contracts are liquidity pools. Anyone with a digital wallet can connect to one of Uniswap’s many liquidity pools to add liquidity.
Source: Uniswap
In this way, users become Liquidity Providers (LPs), replacing the need for Market Makers. First, they choose a pair of tokens and then deposit tokens from their wallet, which locks the funds for a period of time. In return, LPs receive a small share of the exchange when traders exchange one of the tokens locked in the liquidity pool.
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While this permissionless self-monetization is elegant, the liquidity of each token pair depends on the popularity of the platform itself. Additionally, even if a DEX like Uniswap is popular, there may be lesser-known small-cap altcoins that have very small liquidity pools.
On centralized exchanges (CEXs) like Binance, the exchange would step in with its central deep liquidity to cover such trades. But how would DEXs solve the low liquidity problem?
How do DEXs mitigate low liquidity?
What happens if a token pair has low liquidity? Without a price adjustment, exchanging one token for another, slippage occurs.
Since there are not enough tokens in a token pair (liquidity pool), the trade order has to wait. During this time, the expected swap price differs from the actual swap price. Slippage is the percentage that measures this difference. In the crypto world, where most cryptocurrencies are inherently volatile, the slippage problem is acute.
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So there has to be a tracker that finds the best pool of liquidity to quickly fill a swap order with the lowest percentage of slippage. A DEX aggregator is just such a tracker. From a single dashboard, DEX aggregators connect to multiple DEXs to find the optimal liquidity pool for each token pair.
Of course, this match search is automated with smart contracts in the background. The end user just sees a user-friendly window to choose which token to exchange for another token. On the most popular DEX aggregator, 1 inch, such an interface looks like this.
Within this single interface, DEX aggregators audit liquidity pools across hundreds of DEXs and even across different blockchain networks. For example, 1 inch supports token swaps across ten networks.
Without DEX aggregators, finding the optimal token swap on a DEX would be extremely time-consuming and inefficient.
Benefits of using DEX aggregators
Let’s say you are a crypto whale. Even a single pool of liquidity on the most popular DEX would not suffice for the amount of tokens you wish to trade. In this case you would go to a DEX aggregator who would find the most optimal trading position with the least possible deviation.
Even if a popular DEX has high liquidity pools, that doesn’t mean it would offer a better execution price. There may be a lower fee liquidity pool with a one-way token pair ratio that would perfectly suit such a specific trade. A DEX aggregator makes this easily possible.
Another major advantage is that even crypto whales do not have to reveal their identity to trade. Typically, whales go to over-the-counter (OTC) exchange offices for large volume trades. The problem is that they are legally required to register using the know-your-customer (KYC) process.
With both DEXs and DEX aggregators, this is not necessary as the entire protocol is automated and, you guessed it, decentralized.
Top DEX Aggregators
To connect to any DEX aggregator, all one needs is a non-custodial wallet like MetaMask. All DEX aggregators have almost identical interfaces. All things being equal, it would be wise to review each one to see how well it matches specific trade orders. Finally, this is dynamic as DEX liquidity depends on user participation and market conditions.
1 inch
1 inch – this DEX aggregator has by far the largest number of token pairs and covers most networks. As of November 2022, it covered $254 billion in trading volume from 309 liquidity sources.
1inch also has its own token called Chi Token that can be used to cover ETH gas fees. Otherwise, 1inch does not charge any fees for withdrawals.
open ocean
OpenOcean — is among the first DEX aggregators, covering 18 blockchain networks with over 200 liquidity sources. In addition, the world’s largest CEX, Binance, OpenOcean also provides liquidity and delivers low-slippage trades for over 143 token pairs.
ParaSwap
ParaSwap – a DEX aggregator with its own liquidity pool – ParaSwapPool for particularly low slippage measures. ParaSwap covers seven blockchain networks and has over 65 liquidity sources.
ParaSwap’s strength is its integration with the most popular DeFi wallets and dApps – Aave, MetaMask, Ledger, Argent, Enzyme and Zerion.
Paraswap also has mobile versions for Apple users, while an Android app is coming soon. Since this DEX aggregator has its own liquidity pool and PSP tokens, users can stake them to earn rewards.
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DEX Aggregators: Essential DeFi cogs
DEX aggregators are one of those innovations that don’t displace existing dApps but add another layer to them. By connecting hundreds of liquidity pools from DEXs together, they all but eliminate the main stumbling block of DEX trading – low liquidity leading to slippage costs.
There are no downsides to using DEX aggregators. In fact, one should get into the habit of using multiple DEX aggregators to see which consistently gives the best results.
Disclaimer for the series:
This series article is for general guidance and information only for beginners participating in cryptocurrencies and DeFi. Nothing in this article should be construed as legal, business, investment or tax advice. Consult your advisors for all legal, business, investment and tax implications and advice. The Defiant is not liable for lost funds. Please use your best judgment and exercise due diligence before interacting with Smart Contracts.
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