Abstract

This piece contains a deep dive into problems in DeFi, technical properties of SUAVE and how these properties can address some of the problems faced by DEXs and auction protocols.

Decentralized Finance (DeFi) is arguably the most important application vertical within blockchain technology and has the most significant potential to drive mass adoption of this technology. Central to the DeFi ecosystem is the non-custodial decentralized exchange (DEX) trading. However, trading on centralized exchanges (CEX) provides a better user experience due to improved execution, lower cost of trading and more profitable liquidity provisioning. Privacy preserving and credible computation guarantees SUAVE provides by leveraging Trusted Execution Environments (TEEs), coupled with low latency design offer a design space that can improve auctions and DEXs, which may help DeFi and blockchain application adoption in the long run.

This study synthesizes market data, academic research, and insights from comprehensive interviews with diverse DeFi stakeholders, including market makers, venture capitalists, Miner Extractable Value (MEV) supply chain participants, and industry experts. These interviews offer firsthand perspectives on operational dynamics, existing inefficiencies, and the key adoption hurdles in the DEX arena. Additionally, the study conducts an in-depth analysis of the DeFi ecosystem, with an emphasis on Decentralized Exchanges (DEXs) and auction mechanisms, to explore prevalent problems, proposed mitigation strategies, and the role of privacy for an improved user experience. The study also evaluates the potential of SUAVE-based approaches in offering solutions to these challenges and in enhancing existing practices.

The findings indicate that DEXs often provide a suboptimal trading experience compared to CEXs, primarily due to factors like lower liquidity and higher cost of trading. Two principal reasons contribute to this situation:

  1. The inherent discrete-time nature of blockchain operations, typically 12 seconds on Ethereum, compared to the continuous price movement on CEXs, which serve as reference points, creates arbitrage opportunities. Delayed price updates on DEXs enable arbitrageurs to exploit passive liquidity providers, a phenomenon termed Loss-Versus-Rebalancing by Milionis et al. [6].
  2. The high cost of actively managing liquidity positions on DEXs, in contrast to the cost-free order placement and cancellation on CEXs, leads most LPs to set wider ranges for their positions, thereby spreading liquidity over a larger spectrum and reducing active liquidity near the market price, as observed by Caparros et al. [41].

Moreover, the public nature of blockchain transactions exposes traders to adversarial ordering attacks, diminishing the quality of trade execution and increasing trading costs.

As a result, trading and providing liquidity is less profitable on DEXs. In order to mitigate these problems, there’s a trend towards auction based solver and Request For Quote (RFQ) based DEXs, which prioritize active liquidity management. These auctions are currently held off-chain in centralized systems that require trust, due to current limitations of blockchain based auction protocols to meet the demands of efficient trading systems. Furthermore, credibility of digital auctions is a problem that extends far beyond blockchains. The DoJ recently sued Google over auction manipulation and distorting auction competition [41].

SUAVE has the potential to emerge as a promising solution for the DeFi ecosystem given its focus on privacy, fast finality, credible off-chain computation properties and Ethereum compatibility. SUAVE can allow DEXs to be competitive with CEXs by:

In conclusion, SUAVE's characteristics could substantially contribute to addressing current inefficiencies in DeFi, particularly in decentralized exchanges and auction mechanisms.