The Rise of
Interchain Decentralized Exchanges and Liquidity
While the concept of decentralized exchanges (DEX) is nearly a decade old, they were never in the spotlight fully until the beginning of the most recent bull run at the end of 2020. Before then, nearly all crypto trading was performed on centralized exchanges (CEX), most of which still require identity verification and introduce other limitations.
Being home to many new tokens that were not found elsewhere, DEXs became the place to place risky bets on unproven tokens and either watch investments flourish or be left with illiquid tokens. However, many began using DEXs even for normal trading due to the private and borderless nature of the protocols, eliminating the need for any type of identity verification. It has even become possible to trade decentralized perpetual contracts on protocols such as dYdX.
The chart below shows the monthly volume of several DEXs. Their volume exploded in a small time frame and solidified their place as a cornerstone of decentralized finance; they are here to stay. However, they do not yet communicate across chains, which means that swaps and liquidity both stand independent on each chain.
Source: Dune Analytics
Interchain Challenge
The past few years have seen many alternative chains and smart contract platforms rise in popularity and usage, such as Solana, Avalanche, Polygon, and others, all of which have their own DEXs, tokens, and ecosystems. Many traders operate across all these chains daily and as such, they use different solutions to move their liquidity from one chain to the other.
One such solution is to deposit a chain’s native token, such as Solana, to a CEX, exchange the token for another chain’s native token, such as Avalanche, and finally withdraw the new token to the new chain. This process moves liquidity from one chain to the other, yet it exposes the user to price volatility while the token is depositing to the CEX, excess time consumption while waiting for the deposit and withdrawal, and privacy concerns regarding the required identity verification by many CEXs.
Bridges are the decentralized solution.
Bridges: Expensive and Slow
In essence, a bridge is a smart contract on a chain to which you can deposit a token and receive an equivalent amount of the token on another chain. For example, if you deposit ETH to the Polygon bridge on the Ethereum Mainnet, the bridge will mint an equivalent amount of ETH on Polygon to your wallet, and hence transfer your liquidity from Ethereum to Polygon.
Source: MakerDAO
This works flawlessly mostly, and yet it is a slow process and involves gas fees that could be mitigated with other solutions. For example, to bridge from Arbitrum back to the Ethereum Mainnet, the bridging process takes seven days to complete, which is a long amount of time to support a proper flow of liquidity between chains. Protocols such as Hop Exchange offer the same bridging process that completes in less than ten minutes, yet these involve further fees and still can take quite a long time.
Furthermore, these bridges do not offer the possibility to swap a token from one chain to a different token on the other chain, such as swapping ETH on the Ethereum Mainnet for USDC on Arbitrum. This would involve an extra step that would consume even more time and fees.
It seems there exists an opportunity for a protocol to bring true interchain swaps and liquidity. The usage of alternative chains is increasing month by month and more individuals are using their liquidity across several chains daily to trade and participate in the different ecosystems each chain offers.
Stargate: A Proposed Solution
Stargate is a new dApp that aims to bring interchain swaps and liquidity, built on the LayerZero protocol.
While native bridges use locking, minting, and burning mechanisms, all of which can contribute to time consumption and excess gas fees, Stargate is taking a different approach by creating liquidity pools that multiple chains can access, unifying their liquidity to allow the swapping of tokens across independent chains.
According to Stargate themselves, there are three features that make up the perfect bridge:
- Instant guaranteed finality
When the transaction on the source chain is confirmed, funds are instantly available on the destination chain - Unified liquidity
A single pool of liquidity that both chains can access - Native assets
Able to use native assets when swapping across chains, and not wrapped tokens
Source: Stargate Medium
Stargate has created the so-called Delta algorithm that allows a bridge to implement all of the above. For example, it allows for the swapping of ETH on Ethereum to AVAX on Avalanche, all in a single transaction, using native tokens from unified pools, hence there is no longer a waiting period nor multiple gas fees associated with a normal bridging process.
Any DEX, such as Uniswap, can implement Stargate to allow interchain swaps and present it to their users in their front end as a simple one-transaction swap; the magic happens behind the scenes using the Stargate protocol. Diving into the technicalities that makes this process possible is beyond the scope of this article but interested readers can delve further into the topic by reading the Stargate documentation.
Users are not the only ones benefiting from this new process, protocols do too. dApps that operate on multiple chains can use Stargate as an alternative solution to moving their assets between chains as they require. This presents many new yield opportunities and could lead to a reduction in fees associated with many popular DeFi products.
Stargate is launching on seven chains initially, which includes Ethereum, Avalanche, Polygon, Binance Smart Chain, Fantom, Arbitrum, and Optimism. They have plans to add support for other chains such as Solana, Terra, Cosmos Hub, and Osmosis.
A Common Goal
Many of the main attractions of cryptocurrencies are their speed, borderlessness, privacy, and universality. As the state of crypto moves towards the use of multiple chains for different purposes, it becomes vital to allow for the efficient transferral of liquidity across these chains with speed and minimal fees. The current solutions, by using a CEX or traditional bridging, each present downsides that halt alternative chains from reaching their full potential in terms of active participation.
Stargate’s proposed solution could pave the way for a new direction in which decentralized finance is heading: an interchain universe and the free flow of liquidity between all chains.