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The competition between market makers and DEX provides 0x end users with the advantages of passive and active liquidity, and few other exchange agreements can provide this kind of service.
Original title: “An article to understand how the 0x protocol aggregates the decentralized liquidity of Layer 2 and Layer 1”
Written by: John Freyermuth, Messari Analyst Translator: Kyle
The sources of liquidity are being scattered among the Ethereum Layer 2 scaling solutions and other Layer 1 networks. Aggregators must make trade-offs when choosing which L2s they will run on. Aggregators will make exchanges fungible, a popular argument that has not yet been confirmed. Before that, aggregators must build applications on L2 and other networks to attract the most exchange liquidity. These decisions create a trade-off, because aggregators may choose to abandon the source of liquidity on one chain and use another chain instead, such as abandoning deployment on Rollup and deploying on high-growth sidechains. Before the interoperability infrastructure is fully developed, the fragmentation of the trading market may deepen.
The 0x project is very suitable for decentralized liquidity. As a set of developer tools, 0x provides peer-to-peer liquidity functions for other Ethereum-based applications. It is wrong to compare 0x with a decentralized exchange (DEX). Unlike decentralized exchanges (DEX), 0x breaks down liquidity by enabling the trading of combinable assets in any application. The core function of the project is the exchange API, which connects users and applications to liquidity sources in the most effective and available way. When the 0x API connects the order taker to the DEX, 0x acts like an aggregator. In addition to the API, 0x also provides its own market maker community to fill 0x orders. When the DEX cost is relatively high, 0x can connect the order taker to its internal market maker network, such as an exchange. The 0x protocol always seeks the lowest cost transaction, so it subsidizes the market maker’s cost through ZRX token rewards to keep its price in competition with the most liquid exchange. 0x uses DEX and aggregator functions to maintain a competitive asset market among all decentralized resources. The diversified liquidity network distinguishes 0x from DEX and aggregators, and the token economics of the project gives it a competitive advantage over the two.
Uniswap and Sushiswap have dominated the DEX market with passive liquidity in the past year. These and other top DEXs pool the supply of assets from token holders seeking income from deposits. Automated sales mechanisms enable DEX to seamlessly meet most market needs. However, 0x’s market share shows that nearly 7% of DEX transactions require active liquidity.
The latest 0x platform has unique advantages and can benefit from cross-L2 liquidity fragments. 0x v4 emphasizes that the focus of their historical market makers is to maintain market competitiveness among any number of sources of liquidity. With the rapid growth of the market, they will strive to obtain users by reducing costs. The tool suite of the platform routes 0x orders through the 0x API, and settles to users at the lowest possible cost. The agreement rewards market makers to provide liquidity directly through the 0x local exchange infrastructure, and ultimately try to beat DEX pricing. Through 0x, these market makers can provide all 0x API users or recipients who constitute the demand side of each market. 0x API provides an out-of-the-box liquidity source for other applications to meet any number of user asset exchange needs. Currently, applications can be built on 0x API to access the market supply within the network, namely Ethereum L1, L2 or Binance Smart Chain (BSC).
0x provides a set of tools for blockchain native applications to directly match redemption orders at the lowest possible cost. The 0x protocol performs matches off-chain and then resolves them on-chain to reduce network usage and the cost of each transaction. 0x local trading volume includes all 0x orders from repeaters, aggregators and 0x market makers. 0x API transaction volume only includes exchange endpoints, recipients and demand-side origins. 0x API transaction volume overlaps with 0x Native transaction volume, because 0x API orders can access 0x Native liquidity sources. Matcha transaction volume includes all orders completed on the web application. Because Matcha is built on 0x API, the transaction volume overlaps with 0x Native and 0x API transaction volume.
The product transaction volume in the past year shows that 0x Native resources provide most of the network’s liquidity. 0x API transaction volume includes Matcha transaction volume, because the aggregator is built based on 0x API. However, 0x API can aggregate DEX and 0x Native liquidity sources. In the past year, 0x Native transaction volume exceeded 0x API transaction volume. Whether it is routing through applications such as Zapper.fi and MetaMask, or directly obtaining liquidity through proprietary trading services, the 0x network satisfies the 0x protocol transaction volume more than all exchanges available to 0x API users.
As an aggregator, Matcha gained market share, but fell behind the 1inch agreement throughout the year. On Ethereum, 1inch dominates the total transaction volume. Since May 2020, 1inch has obtained an average of 10% of all Ethereum DEX trading volume. This aggregator leader provides DeFi users with a vertically integrated one-stop trading interface. 1inch’s mission is to conceal the source of transactions by providing the simplest execution at the lowest cost. 1inch has effectively secured its market leadership by focusing on DEX aggregation.
Although Matcha is trying to compete with 1inch on the DEX aggregator track, the 0x protocol uses diversification to drive transaction volume and gain value as a liquidity aggregator. The 0x market maker network does not primarily or completely obtain liquidity from DEX, but provides a large amount of liquidity outside of the DEX market. 0x API routed 4% of all Ethereum L1 DEX transaction volume in May 2021, and it was also 1 inch behind for the whole year. In the same month, 0x networks almost doubled this number. In the 0x protocol, the liquidity on the custom chain has surpassed the liquidity on the polymer chain in each of the past 12 months.
Composable application development tools provide the advantages of 0x. With 0x, application developers can keep focusing on the main purpose of their application while outsourcing the end-user asset exchange function. 0x Market makers can obtain diversified needs. Market makers can meet large and small orders by competing with 0x API aggregated DEX liquidity. Applications built using 0x API or other exchange development tools provide users with competitive active and passive liquidity.
0x Token Economics
For 0x and other aggregators, the off-chain order matching efficiency will mainly drive the network value, and competition will eventually reduce the aggregation cost to zero. With aggregators and switching capabilities, the 0x platform supports this principle. According to the 0x team, 0x API routed nearly 4% of last year’s DEX transaction volume because it kept transaction costs low. Where DEX provides passive liquidity, 0x provides an active network of market makers who own a large portion of the DEX market share. The two features of the 0x protocol solve the problem of cost compression, and the new initiative is to maintain the advantages of the protocol in the future.
0x Market makers charge agreement fees as liquidity rebates. This rebate has four design goals to improve the 0x market making platform. First, the agreement fees are designed to earn more income from arbitrage transactions than personal retail exchanges. Second, the fee structure is applied equally to small and large market makers to create equal competition. Third, fees encourage user ownership and governance participation. Only market makers can operate the staking pool, and ZRX holders can participate in the staking pool operated by market makers. Fourth, 0x aims to create a simple method for market makers to predict how liquidity fees will affect their bottom line.
Takers pay the 0x platform fee in proportion to the gas cost of the transaction. Fees are paid in ETH at the time of execution, so users only experience the cost once per transaction. Relative to low gas prices, other transaction fee models may become expensive and may exacerbate high gas prices. Regardless of the gas price, the 0x protocol fee is designed to be equally expensive. Recently, the 0x protocol DAO voted to lower their gas price multiplier because the gas price has risen to a historical high.
0x order fees are only incurred by ZRX pledgers in the pool that must be operated by 0x market makers. Market makers earn fees proportionally based on the liquidity they provide and their ZRX share. Any excess fees will be transferred to the 0x Treasury for platform development.
Market makers can only increase their share of agreement fees by increasing transaction volume. The only way to increase trading volume is to beat the DEX price. In the past three months, 0x protocol fees only increased with the increase in transaction volume. At the same time, ZRX’s pledge amount fluctuates, but the amount is growing. The ratio of cost to ZRX value increases as the amount of 0x protocol increases.
The rewards of the ZRX staking pool improve the 0x end user experience. 0x Agreement fee subsidies market makers to provide supplies that meet DEX prices. Market makers get more rewards when they meet more needs. Token holders can pledge ZRX in the pool of successful market makers to passively earn income. Market makers and pledgers work together to maximize ZRX rewards by maximizing their fee to pledge ratio. Therefore, as the ZRX pledge increases, market makers must generate more transaction volume to increase fees. More ZRX rewards enable market makers to maintain competitive prices to increase trading volume, especially when DEX pricing is slowly adapting to market conditions. Subsidy 0x market makers can ensure that end users can complete orders at the most favorable price. The 0x protocol uses ZRX liquidity rebates to align market maker incentives with end-user benefits.
0x v4 aims to keep up with market makers and DEX because the protocol can be ported to many blockchain networks. When developers want to build exchange functions in Web3 games or new digital asset wallets, they will carry 0x with them. Just like Matcha demonstrated, the entire exchange aggregator application can be built on 0x. The 0x project is designed for DeFi builders.
Market makers and application developers are 0x target users, and 0x token economics motivates them to optimize the end user experience. The cost of the agreement serves as a liquidity rebate to reward market makers’ transaction volume growth. The fee offsets the competitive pricing that market makers must provide to compete with the 0x API aggregated DEX. The competition between market makers and DEX provides 0x end users with the advantages of passive and active liquidity. Few other exchange agreements can provide the best of both worlds.
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