Written by Yellow Propeller
Compiled by: TechFlow
Summary of key points:
Economies of scale lead to centralization of the trading supply chain: The lack of standards and the resulting complexity creates economies of scale for solvers, searchers, builders, liquidity providers (LPs), and decentralized exchanges (DEXs), which drives their centralization.
Centralized exchange supply chains make DeFi more vulnerable: Decentralized finance (DeFi) is centered around exchange operations. Even if the underlying protocol is decentralized, centralized exchange supply chains are still vulnerable to censorship and exploitation.
Simplify the solution, liquidity provision, and trading process: To build a robust and efficient financial infrastructure, we need to simplify tasks in the trading supply chain and make them simple enough for small teams to compete and achieve decentralization.
Transactional supply chain complexity concentration
If you look at trends in resolution, market making, and blockchain construction, you’ll see that the trading supply chain is moving toward centralization.
However, this is not inevitable. Centralization occurs because of economies of scale, as the workload of many participants in the transaction supply chain becomes too onerous.
The solution is to simplify these roles so that independent operators can compete. This will maintain diversity, decentralization, and innovation in solutions, search, blockchain building, decentralized exchanges (DEX), and the decentralized applications (dapps) built on them.
In this article, we will explore the root causes and limiting assumptions that lead to the current complexity of market making, solving/searching, and on-chain transactions.
Complexity leads to centralization of market making
The original intention of automated market makers (AMMs) was to make market making so easy that anyone could become a market maker by simply making a “deposit”.
However, since the launch of Uniswap v2, the situation has become more complicated: now, you either need to put in a lot of effort to manage your liquidity positions or rely on additional automated tools.
At the same time, active market makers account for a larger share of DeFi trading volume. It is worth noting that the traffic is mostly controlled by a few teams rather than shared by a diverse group of participants.
Market making tends to be centralized because it is so difficult to do well.
The reasons why market making is difficult are summarized as follows:
Trading across multiple markets: Liquidity is distributed across multiple markets, including spot, futures, and perpetual contracts on and off the chain. You need to manage inventory and hedge across all these markets to provide the lowest spreads and win the most trading volume. You also need to build and maintain multiple integrated systems to effectively manage inventory and risk in the competition.
Protection against harmful traffic: To avoid losses, you need to dynamically adjust the spreads for buyers and put them on whitelists, blacklists, or greylists. This requires constant monitoring and heuristic analysis.
Winning the latency race: Obtaining the latest price information (from centralized and decentralized exchanges) and executing trades are both a race about latency. The smaller the latency, the smaller the spread you can offer, and the more traffic you can win. Latency optimization is a never-ending process, and you need to continuously optimize various aspects such as network, computing resources, and business development cooperation.
Increase liquidity and reduce fees: Your ability to trade depends on the liquidity on a certain platform or chain. The less fees you pay (for example, by increasing your rank on a centralized exchange), the more competitive your quotes will be, thus winning more trading traffic.
These barriers create a positive feedback loop that makes it easier for existing winners to remain ahead and harder for new market makers (including automated market makers) to enter the market.
But this is not necessarily the case.
Market making can actually be very simple
Often, people think that market making is both necessary (because it incorporates market signals) and difficult (because it requires liquidity, low-latency infrastructure, risk management, and system integration), so we can’t do without it. However, the complexity of market making is not due to the nature of the work—it’s not as complex as predicting protein folding—but rather to the existence of zero-sum competition that is driven by imperfect market design.
There are three main flaws in the market:
Time priority: Time priority (or prioritization) mechanisms lead to latency races and are a major cause of complex market crossovers and harmful traffic.
Lack of standards: The lack of uniformity in exchange interfaces (whether on-chain or off-chain) makes market crossing more complex than it needs to be.
Lack of coordination: Lack of effective coordination among small players makes having large amounts of liquidity a competitive advantage.
The core of market making is simple: provide liquidity at market prices and add a spread to cover the cost of capital. If the prices in the two markets are different, buy from one and sell in the other. The rest is competition and confrontation caused by market design flaws, which does not bring any substantial benefits to end users (e.g., better prices).
Complexity of on-chain routing and searching
The sources of market making complexity have been no great secret since Flashboys. But what makes solving and searching difficult, and what separates the good from the rest, is less well known.
Let’s break down why solving these problems is so difficult:
Indexing Liquidity: The most labor-intensive task for solvers is integrating with every decentralized exchange, lending, staking, stablecoin library, and market maker. Integration means understanding the internal mechanics of the protocol (including its mathematical principles) and how logs and storage slot updates are mapped to prices and exchange functions.
Routing: Designing and scaling algorithms that can efficiently combine orders, route them, and split them across liquidity pools is a hard problem. It’s even more challenging if you only have a few hundred milliseconds.
Relationships: Solving the problem also involves a lot of business development work. You need to get auction platforms to whitelist you, get wallets and aggregators to integrate your service, get traders to trust your API, and reach cooperation with developers. Get audits, pay deposits, and build a brand to get more opportunities.
Countless small issues: Each auction, chain, and execution environment has its own uniqueness and design flaws. Many of these issues are not directly related to providing better prices to users. This takes time to learn, adapt, and manage.
If the solution is too complex – the intention will be to centralize
The intent is here to stay. Most new decentralized exchanges (DEXs), bridges, and cross-chain architectures are explicitly designed with solvers at their core.
However, problem solving is already difficult enough. Add to that tasks like inventory management, search, or market making, and having a single solving team handle it becomes impractical for most teams.
Protocols that expect solvers to be able to fulfill all of these roles will struggle to attract enough solvers to participate — and may have to accept a certain level of centralization.
Small DEXs are difficult to integrate
Except for the largest DEXs, all other platforms are struggling to attract traffic.
Many well-designed DEXs have not achieved the total value locked (TVL) and trading volume they were designed to achieve.
Besides the obvious reasons of brand, marketing and resources, there is also the fact that even the largest DEXs have difficulty integrating into order flow sources.
Solvers and routers can barely keep up with the largest sources of liquidity, but they don’t have the time to integrate and learn the intricacies of smaller DEXs.
Just a few hooks of Univ4, even if there are only 5-10, will require months of integration work.
As a result, large DEXs gain integration and attract more traffic, while smaller DEXs do not. As traffic decreases, liquidity providers (LPs) receive less returns, so LPs leave. Reduced liquidity in DEXs leads to price deterioration, which further reduces traffic on smaller DEXs.
So, in an ecosystem where traffic comes from integrations — but you can only get integrations if you already have traffic, liquidity, or brand — small or emerging DEXs have little chance of competing.
The complexity of transactions keeps traders away from the chain
The poor user experience of on-chain transactions seems to be a cliché. But instead of discussing the problems of bridging or account management, we will focus on the wrong assumptions behind transactions.
Currently, we offer order types similar to those used by professional traders in traditional finance. However, our execution infrastructure is completely different from traditional finance and its goals are also different (no central dependency, open access, transparent execution).
Therefore, our trading environment is neither suitable for ordinary investors nor professional traders:
There are numerous parameters: traders need to set slippage, gas fees, limit prices, choose urgency, and monitor the execution of their orders.
Complex context: transactors also need to at least implicitly consider block times, market volatility, priority fees, and any possible MEV attack vectors, such as the cost of transaction transparency.
The interface is not user-friendly enough: For professionals, AMM curve math, MEV bundling, priority fee prediction, and even running a block builder - these are all very challenging learning curves that only the most curious and determined companies will attempt.
Uncertain compliance: Lack of compliant exchanges, audit logs, and trade assurances prevents large funds from participating in trading.
No wonder — so many trades go through intermediaries that custody assets and provide familiar and simple interfaces (like centralized exchanges, OTC desks, and Telegram bots).
To achieve decentralization — we need to simplify
Not only does unnecessary complexity waste resources, it also fosters economies of scale that favor centralization.
A centralized transaction supply chain will be fragile and susceptible to censorship and exploitation.
Worse, it stifles innovation because high barriers to entry make it difficult to launch new designs.
Such decentralized finance is no different from traditional finance.
A healthy decentralized financial ecosystem requires a decentralized transaction supply chain.
The path to decentralization is simplification.
What a simple transaction supply chain should look like
A healthy decentralized trading supply chain should have the following characteristics:
Passive liquidity providers: Participants with the lowest capital cost (such as long-term holders) provide liquidity to the market. Liquidity provision is a "single operation" that is easy to understand and simple enough to be automated. Many people can participate in providing liquidity.
Open to innovation: If designed properly, developers of newly designed decentralized exchanges (DEXs) can gain equal access to order flow and initial user traction. Any individual contributor in the exchange supply chain can improve specialized components and thus gain access to traffic.
Simplified trading: The market design is simple and easy to understand, aiming to optimize the user experience. The market aggregates signals cost-effectively (known signals such as arbitrage can be solved cheaply, while novel signals are rewarded) and does not leak value. Therefore, most transactions are driven by directional demand (such as buyers and holders), and transaction fees are almost negligible.
As a result, the transaction supply chain will be both efficient (low cost and fast) and robust (decentralized, open and trustless).
Building a decentralized trading supply chain
Complexity can lead to permanent centralization of the trading supply chain, creating an exploitative, fragile, censorship-prone, and stagnant ecosystem. Our goal is to change this by simplifying the process of creating, resolving, and trading markets, and decentralizing the trading supply chain. Over the next few days, we will deliver three key elements to this goal:
A standard to combat liquidity fragmentation.
A tool that simplifies coordination between solvers and liquidity providers.
A new market without delayed competition and trust assumptions.
