Decentralized Limit Order Book: What It Is & Why We Created Fusion AMM
The evolution of the digital age has illuminated the shortcomings and vulnerabilities of traditional financial systems and centralized exchanges, exemplified by the recent challenges faced by platforms like FTX. These occurrences underscore the urgent need for a transformative financial framework prioritizing security and transparency. While we introduced a financial framework within our platform to trade NFT perps on-chain with our Protocol-as-LP vAMM V1 design, we realized that this had its own set of limitations and needed further innovation to help with scale.
Decentralized on-chain limit orders are an alternative, presenting enhanced security, transparency, and accessibility. The inherent benefits of this decentralized approach position it as a pivotal solution for traders and industry pioneers striving to establish a more secure and transparent financial ecosystem.
What is a Decentralized Limit Order Book?
A Decentralized Limit Order Book (DLOB) is a concept within decentralized finance that serves as an integral component of decentralized exchanges (DEXs). DLOBs can be conceptualized as a virtual platform where individuals intending to trade cryptocurrencies can list their trading parameters, detailing the specific cryptocurrency they desire to buy or sell and their intended price. This decentralized platform acts as a dynamic marketplace where buyers and sellers converge to trade digital assets, all facilitated through blockchain technology, guaranteeing all trades’ security, transparency, and integrity.
Within a DLOB, traders place orders subsequently recorded on the blockchain. There are many order types, but the limit order is prevalent, which allows traders to designate the maximum or minimum price they are willing to transact at. These orders are publicly accessible and persist in the order book until matched with a compatible counterorder, enabling a direct, peer-to-peer asset exchange without intermediary involvement.
Centralized Limit Order Books (CLOB) vs. Decentralized Limit Order Books (DLOB)
When exploring the world of trading and crypto, you might come across Centralized Limit Order Books (CLOBs) and Decentralized Limit Order Books (DLOBs). And while they serve similar purposes, the way they operate is quite distinct.
A Centralized Limit Order Book is like a traditional marketplace managed by a single entity, usually a centralized exchange. This central entity handles matching buy and sell orders, ensuring everything runs smoothly. This is like having a market overseer who organizes all the trades and ensures everyone gets what they are looking for. However, this central authority holds control over the trades and user funds, and traders rely on the security measures of the centralized platform to protect their assets.
On the flip side, a Decentralized Limit Order Book operates on a network of computers on a blockchain, allowing traders to retain control over their funds and execute trades directly with one another. DLOBs can be like a community-run marketplace where everyone contributes to maintaining order and security. In this setup, no central authority oversees the trades, and the users enjoy more freedom, anonymity, and transparency. The blockchain technology and smart contracts underpinning DLOBs ensure that all trades are secure and recorded permanently.
While both CLOBs and DLOBs have advantages and challenges, the choice between them often depends on the individual’s preferences, trading needs, and the level of control and security one desires in their trading endeavors.
Benefits of Decentralized Order Books
- Enhanced Security: Utilizing blockchain technology, DLOBs offer robust security features, mitigating the risks of hacks and unauthorized interventions.
- User Control and Ownership: Users maintain full control over their assets and trading activities, allowing them to manage their funds without the interference of a central authority.
- Transparency: The blockchain records all transactions and orders, providing a clear, immutable, and publicly accessible ledger of all trading activities.
- Reduced Counterparty Risk: Eliminating intermediaries in DLOBs minimizes the reliance on third parties, reducing the associated risks and enhancing the reliability of trades.
- Access and Inclusion: DLOBs are generally accessible to anyone with an internet connection, promoting financial inclusion and democratizing participation in cryptocurrency trading.
Cons of Decentralized Limit Order Books (DLOBs)
- Liquidity Concerns: DLOBs often struggle with liquidity issues, especially in their early stages or in niche markets, which can impact the ease of trading and price stability.
- Complexity and User Experience: The decentralized and technical nature of DLOBs can be intimidating and complex for beginners, potentially leading to a steeper learning curve and impacting user adoption.
- Interoperability: DLOBs operating on different blockchains may face challenges in interacting with each other, which can limit the seamless exchange of assets across different networks.
Our Fusion AMM: Combining Constant Liquidity AMM with DLOB
In the next evolution of nftperp, we set out to introduce a hybrid liquidity protocol called Fusion AMM that combines a constant liquidity AMM with a decentralized limit order book (DLOB). Fusion AMM leverages the competitive advantages of both systems and serves as a perpetual liquidity provider at the base source layer. With this comes benefits such as ensuring that there is always liquidity available for takers to enter or exit positions, allowing for isolated and customizable pool parameters to address individual market risks, and enabling easy bootstrapping for new pairs. Lastly, our approach allows anyone to be a maker on the protocol with automated bid/ask strategies, enhancing the overall trading ecosystem with precision and orderliness facilitated by the DLOBs.
This sophisticated fusion not only inherits the benefits of limit order book liquidity, such as ease of price discovery and direct counterparties for takers and makers, but also scales to increase market depth and reduce price impact on significant orders. The Fusion AMM acts as an independent market maker within the DLOB, providing liquidity on both tails of the curve and ensuring minimal price impact on markets when order conditions are matched, leading to less slippage and better pricing around the mid-price. In essence, nftperp’s Fusion AMM is a massive step forward for our NFT trading platform, representing a seamless blend of immediacy, precision, and innovation aimed at optimizing market depth around the market price and mitigating price impact on large orders.