What is vertex? [Sponsored] – The defiant

The collapse of FTX raised doubts about the concept of centralized platforms. In contrast, decentralized exchanges offer both transparency and self-custody. But how can DEXs fill the liquidity gap that CEXs offer?

Vertex Protocol, a decentralized trading platform, aims to solve this problem through a number of innovative solutions such as: B. Cross-margining, near-instantaneous order execution, no MEV and vertically integrated products. To understand what this means, we must first understand why decentralized exchanges have not gained as much traction as CEXs.

Centralized Exchanges (CEXs) = high liquidity

November’s FTX crash wiped out almost a quarter of the value of the global crypto market. It compounded the contagion triggered by the previous failures of Terra, Three Arrows Capital, and Celsius. Before long, more dominoes were falling — BlockFi and Genesis Trading.

They all have one thing in common – a centralized management structure that offers double-digit returns to attract users, reckless deals to stay afloat, and mismanagement of customer deposits.

There was a time when the crypto space was conceived as a decentralized and self-governing system. This included not only Bitcoin as solid money, but also financial services, known as DeFi. Instead, both centralized exchanges and CeFi rose to the top.

Only after the FTX crash did a DEX, Uniswap, make it into the top 5 crypto exchanges. Source: cryptorank.io

The reason for CeFi’s dominance is simple: convenience and high liquidity. The latter is defined by two factors:

• Tight spreads – minimal difference between a bid and an ask price when trading.
• Low slippage – minimal difference between expected and settled trade price.

Centralized exchanges (CEXs) offer both because they don’t rely on users to provide liquidity across numerous fragmented liquidity pools.

In contrast, decentralized exchanges (DEXs) rely on smart contracts to secure user deposits — pools of liquidity. Traders then use their liquidity for different token pairs such as wBTC/USDC or ETH/USDT without having to match existing orders.

In other words, DEXs rely on the popularity of their platforms to attract more liquidity providers to trade efficiently. Additionally, on-chain transactions are as fast as the blockchain network allows. Another problem that does not exist with CEXs.

The Vertex Protocol comes into play to resolve this imbalance between CEXs and DEXs. But how can this be done?

Key benefit of CEXs explained

Like Uniswap, Vertex is a decentralized exchange protocol. However, it uses a Hybrid Order Book Automated Market Maker (AMM). The job of any AMM algorithm, from Uniswap to PancakeSwap, is to track and pool liquidity that comes from separate pools of liquidity provided by users. Then the AMM algorithm returns the available price for each token pair trade depending on the status of the liquidity pools.

In other words, decentralized exchanges allow users to trade with each other on a peer-to-peer basis, but via the AMM algorithm. This is quite different from traditional order books:

• Trades are listed on each side of the ask/bid wall.
• Sell ​​limit orders are shown in red while buy limit orders are shown in green.
• Contrasted and visualized, these ask/sell orders measure the volume on each side of supply/demand, also known as market depth.

The key advantage of a traditional order book is the actual creation of a limit order in the first place. This is the price a trader sets to commit to either an ask (buy) or a bid (sell). So, centralized exchanges can automatically fill these orders when the order reaches the specified price.

Additionally, large CEXs, handling massive volumes, have enough liquidity to execute these trades instantly. This is crucial to avoid slipping. Traders can see the order book volume on either side of the trading equation, which indicates the direction of the asset price.

Bridging the DEX liquidity/execution gap

Now that we understand the difference between order books and AMMs, it’s easier to understand the Vertex Protocol. As mentioned, it uses a hybrid order book AMM. To be as efficient as a CEX’s order book, a DEX would need to offer:

• Low waiting time – Place and execute trades in a split second and view the results. Decentralized blockchains inherently introduce delays as all blocks of transactions have to go through a consensus algorithm across the nodes of the network.

• scalability – the main obstacle to mainstream adoption, which is why Ethereum relies heavily on Layer 2 scalability solutions like Arbitrum or Polygon. This is in addition to volatile gas fees for executing transactions.

• MEV – Miner extractable value. By exploiting smart contract inefficiencies, such as B. the order of transactions in a block, miners are stimulated to make additional profits. Typically run by bot scripts and considered malicious but unavoidable behavior.

• first – For the same reason, both miners and validators, either in proof-of-work or proof-of-stake networks, can use knowledge of upcoming trades to execute their own trades first, before the original ones.

Vertex aims to address these vulnerabilities with a hybrid approach, using on-chain AMM with an off-chain order book. This is a two-tier approach where the off-chain order book, called “sequencer”, runs on top of the AMM algorithm.

In particular, the Vertex AMM matching engine runs fully on-chain on Arbitrum, which means that all trade settlements are executed on-chain as well. This is the default state of Vertex. Vertex Sequencer (EDGE), in turn, stores unexecuted orders, which are later forwarded to Arbitrum for execution.

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By connecting to EDGE, Vertex facilitates the application programming interface (API) to integrate the Vertex protocol with external exchanges to execute trades, in addition to checking asset prices, placing orders, and checking account balances.

This API is the hybrid aspect of Vertex, enabling blazing-fast performance of 10-30ms, comparable to the fastest CEXs like Binance. Visualized, Vertex’s on-chain AMM with the off-chain EDGE sequencer for order matching looks like this.

In practice, the end user connects to Vertex like any other dApp, like Uniswap or Curve. Its sequencer then addresses the above issues with latency, scalability, and MEV/front running.

For a given trade, Vertex’s hybrid order book AMM offers minimal slippage and fast execution while facilitating the trustless nature of DeFi.

At the end of the Vertex line, the ultimate goal is to create a distributed sequencer layer that can serve as a liquidity layer for DeFi protocols across all EVM-compatible chains.

How would Vertex have prevented the FTX fiasco?

Among traders, FTX was known for its line of derivatives: futures contracts, options and of course leveraged tokens. Due to the fact that traders could amplify their market positions with leverage, they could also amplify their profits and losses.

Likewise, it is important to keep in mind that margin trading is a form of leveraged trading, but leveraged trading is not just limited to margin trading. Finally, leveraged trading includes any trading strategy that uses borrowed capital, which could also be in the form of options or futures.

Suffice it to say that maintaining risk in such complex strategies is extremely important. Vertex facilitates this by using cross-margin trading accounts. This means traders can have a single portfolio to manage culprits, spot trades and other money market ventures on Vertex. FTX has become increasingly popular with just such portfolio margins.

With self-custodial wallet access and underlying decentralized layers – Arbitrum and Ethereum – Vertex ensures asset ownership. There is no one who can, at the touch of a button, channel client money to a hedge fund for gambling purposes like Alameda Research.

To do that, the Vertex sequencer would have to be the only off-chain cog to be dishonest. But the sequencer cannot hold users’ funds or fake transactions. Consequently, at worst, users’ trades simply fall back to smart contracts hosted by Arbitrum, leaving the funds intact.

Note: This statement was sponsored by Vertex

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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