The Role of Central Limit Order Book DEX in Decentralized Finance

Finance


A Central Limit Order Book (CLOB) is a digital platform or system that facilitates the trading of financial instruments such as stocks, bonds, commodities, and cryptocurrencies. It is a key component of modern electronic trading and is used on financial exchanges, markets and trading venues to compare buy and sell orders from different market participants.

A CLOB is a database that organizes and manages incoming buy and sell orders by aggregating orders from various market participants. These orders are arranged chronologically to create an order book that reflects the current supply and demand dynamics of the market.

CLOB works on a continuous trading model, allowing orders to be submitted and matched in real-time as new orders are received. CLOBs typically support multiple order types, including limit orders, market orders, stop orders, etc., allowing traders to specify their desired price, quantity and execution time.

When an order is submitted to the CLOB, it is stored in the order book according to its price level and submission time. A transaction occurs when an order matches another existing order, and transaction details are recorded. CLOB aggregates and sorts orders based on price and submission time, ensuring that market participants see the best available prices.

One of the key features of CLOB is to provide transparency to the market. It allows traders to see the current supply and demand levels of the market, including the volume and price of buy and sell orders at various price levels. This transparency allows market participants to make informed trading decisions and assess the liquidity of a particular instrument.

Another important aspect of CLOBs is their ability to efficiently handle large transaction volumes. Modern electronic markets often have a high level of trading activity, with many orders being submitted, modified and canceled in real time. CLOBs are designed to handle high volume orders and execute trades quickly and accurately.

Centralized CLOB vs Distributed CLOB

Centralized CLOBs (cCLOBs) and decentralized CLOBs (dCLOBs) are two different approaches to facilitate trading in financial markets. Centralized CLOBs are widely used in traditional financial markets.

In cCLOB, exchanges play a central role in receiving and matching orders from market participants. The exchange maintains an order book that records all buy and sell orders and executes trades according to pre-defined rules. Exchanges also typically store traded assets and settle trades on behalf of their participants.

In dCLOB, on the other hand, the order book is decentralized and maintained on the blockchain. As a result, there is no central party to match orders or settle transactions. Instead, participants interact directly with the blockchain and submit orders to a decentralized order book. Transactions are executed through smart contracts based on predefined rules. Participants store their assets and payments are automatically made on the blockchain.

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DCLOB is a relatively new concept that emerged with the emergence of decentralized finance (DeFi) platforms, where blockchain technology enables peer-to-peer transactions without an intermediary.

For example, Dexalot is a decentralized exchange (DEX) based on Avalanche that uses dCLOB. The platform includes a detection tool that uses dCLOBs to generate auctions for a period of time (usually 24 hours), during which matching is disabled and all participants submit bids and offers. To do.

This allows participants to observe supply and demand and place them appropriately to control risk deterministically using limit orders.

Dexalot, like cCLOBs, works by keeping a list of buy and sell orders for a particular asset, automatically matching orders and executing trades. However, it runs on a decentralized network, with transactions processed and managed by network members rather than a centralized exchange.

what this means for users

Some in the industry believe that decentralization is beneficial for traders. Pei Cheng, vice president of growth at smart contract platform Rootstock, told Cointelegraph:

“CLOB DEX has the potential to shape the future of cryptocurrency exchanges. By providing , we will contribute to the decentralization and scalability of DeFi.”

“Considering that centralized exchanges face stringent regulations today, CLOB DEXs or decentralized CLOBs have a unique opportunity to move forward by providing a trustless and permissionless environment,” Chen added. That said, the lack of regulatory requirements could also create barriers to adoption, and it is too early to draw any meaningful conclusions.”

Tim Shan, COO of Dexalot, said that despite the decentralized model of his business, centralized CLOBs “have significant advantages over decentralized CLOBs” because they “are not bound by the limitations of blockchain.” Yes,” he told Cointelegraph.

However, he added, “Users should manage their assets in CEX.” [centralized exchanges], allow CEX to use assets for the exchange’s own benefit, face the risk of front-running, and be aware of the possibility of fraud. ”

Another important factor between centralized and distributed CLOBs is the level of control and transparency. cCLOB allows exchanges to manage order books and set rules for order matching, pricing and execution.

Exchanges may also manipulate order books and prioritize certain orders over others. However, this also brings opacity and reliance on the trust of the exchange to act fairly and transparently.

In dCLOB, on the other hand, the order book is transparent and open for anyone to access and review. Additionally, order matching, pricing, and execution rules are encoded in smart contracts and run autonomously without human intervention. This eliminates the need to trust a central party and provides greater transparency and control over participants.

One of the main advantages of cCLOB is its ability to support large transaction sizes with tight pricing. Additionally, centralized exchanges often have rich liquidity pools, which can provide better pricing and faster execution for large trades.

CCLOB also offers more advanced order types such as limit orders, allowing participants to specify a specific price for a trade without slippage. These features make cCLOB attractive to institutional investors and market makers.

According to Shang, technology could be an advantage, especially for CLOB DEX. “Blockchain technology has recently advanced with innovations such as Avalanche subnets and custom virtual machines, which greatly increase speed and throughput and reduce gas bills.” Type CLOB DEX is coming. ”

On the other hand, due to its decentralized nature, dCLOB may face challenges in supporting large transaction volumes with tight pricing. dCLOB liquidity is typically provided by individual participants, who may have limited resources and may not be able to support high trading volumes.

As a result, slippage and price impact can be greater for dCLOBs than for cCLOBs, especially for large trades. DCLOBs may have limited order types and functionality compared to cCLOBs, which may limit the trading strategies that participants can execute.

AMM vs. CLOB

Automated Market Makers (AMMs) were originally created to address protocol-level issues such as speed, finality, throughput, and computational load in blockchain transactions. They revolutionized the trading user experience and effectively wiped out the order book by introducing a simple single-click trading process. AMM uses a formula that continuously defines prices based on the ratio of two assets. Prices change only when participants execute trades and change the amount of assets in the pool.

AMM represents a significant improvement from the early days of blockchain, when transactions were expensive and placing and canceling orders consumed excessive bandwidth and computational resources.

However, AMM had tradeoffs. One of the challenges was creating liquidity. Individual investors provided liquidity by locking up assets in her AMM pool as part of their trading fees. However, this concept, known as liquidity farming, had a drawback called perpetual loss, where the liquidity provider would lose value when the prices of the assets in the pool deviated. In other words, the fees collected were often insufficient to cover the opportunities lost through arbitrage.

Another complication of AMMs, especially those that use fixed commodity formulas, is the difficulty of generating liquidity that can support large-scale trading with tight pricing. To support AMM liquidity, medium-sized trades typically require significant amounts of capital. As the trade size increases, the slippage that occurs also increases significantly.

In comparison, CLOBs are more capital efficient and offer more trading tools, such as limit orders with no slippage, orders with modifiers such as expiry dates, and direct visibility of available depth, allowing traders to It helps you manage your activities in more detail. , can better estimate risk in a deterministic way.

CLOB also offers a better initial and ongoing price detection solution than AMM. On the other hand, direct AMM listings and liquidity bootstrap pool (LBP) style listings (a popular method for bringing new assets to market in DeFi) have significant drawbacks.

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Direct listings of AMM often result in significant price spikes followed by sharp declines due to market manipulation by operators who know how the blockchain works. On the other hand, an LBP that blocks sellers and only allows buyers to participate in the price discovery process for a while creates an unbalanced market that dries up buyer demand, resulting in price gouging and final price cause a decline in

In contrast, CLOBs allow both bids and offers to be included in the order book, making them more suitable for initial and ongoing price discovery. It is also adaptable for opening price discovery through an order book auction mode, similar to traditional financial markets.



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