When Uniswap popularized decentralized exchanges on the Ethereum network, it was a ground-breaking development. DEXs permissionlessly enable users to become liquidity providers for token pair swaps.
DEX liquidity is as deep as there is interest in depositing assets for specific token pairs. It is the job of DEX aggregators to solve this problem by optimally matching swap orders from multiple DEXs.
Why Is Liquidity Important?
In a nutshell, liquidity is money that enables market participants to quickly execute trades and deals. The more liquidity there is, the faster and more dynamic a marketplace. If liquidity becomes scarce, then it can be hard for sellers to find buyers, and that can impact the prices of assets in the marketplace.
This is why traditional markets for stocks, currencies, and commodities have specialized institutions called market makers to stoke trading. These institutions don’t exist in DEX.
The Downside of DEXs
DEXs do not rely on any market-making intervention. An exchange of one token for another is completely automated with the use of smart contracts. For example, on Uniswap, smart contracts are liquidity pools. Any person with a digital wallet can connect to one of Uniswap’s many liquidity pools to add liquidity.
In this way, users become liquidity providers (LPs), displacing the need for market makers. First, they pick a token pair and then deposit tokens from their wallet, locking the funds for a specific period. In exchange, LPs receive a small cut of the exchange, whenever traders swap either token locked in the liquidity pool.
While this permissionless self-monetization is elegant, the liquidity of each token pair relies on the popularity of the platform itself. Moreover, even if a DEX like Uniswap is popular, there may be less known altcoins, with small market caps, that have very low liquidity pools.
On centralized exchanges (CEXs) like Binance, the exchange would step in with its central deep liquidity to cover such trades. But how would DEXs solve the low liquidity problem?
How Do DEXs Alleviate Low Liquidity?
What happens when a token pair has low liquidity? Without a price match by which one token is exchanged for another, a slippage occurs.
Because there is an insufficient amount of tokens in a token pair (liquidity pool), the trade order has to wait. During that time, the expected swap price becomes different from the actual swap price. Slippage is the percentage measuring that difference. In the crypto world, where most cryptocurrencies are inherently volatile, the slippage problem is acute.
So, there needs to be a tracker that finds the best liquidity pool to swiftly execute a swap order with the least slippage percentage. A DEX aggregator is just such a tracker. From a single dashboard, DEX aggregators link to multiple DEXs to find the optimal liquidity pool for any token pair.
Of course, that match-seeking is automated with smart contracts in the background. The end-user only sees a user-friendly window to select which token should be exchanged for another token. On the most popular DEX aggregator, 1inch, such an interface looks like this.
Within that single interface, DEX aggregators check liquidity pools across hundreds of DEXs, and even across different blockchain networks. For instance, 1inch supports token swaps across ten networks.
Without DEX aggregators, seeking the optimal token swap on a DEX would be exceedingly time-consuming and inefficient.
Benefits of Using DEX Aggregators
Let’s say you are a crypto whale. Even a single liquidity pool on the most popular DEX wouldn’t be enough for the amount of tokens you want to swap. In that case, you would go to a DEX aggregator which would find the most optimal trading position with the least slippage possible.
Moreover, even if a popular DEX has high liquidity pools, that doesn’t mean they would offer a better executing price. There may be a liquidity pool with lower fees with a lopsided token pair ratio that would be a perfect match for such a specific trade. A DEX aggregator makes this possible without any hassle.
Another huge benefit is that even crypto whales don’t have to reveal their identity to trade. Typically, whales go to over-the-counter (OTC) exchange desks for large-volume trades. The problem is, they require by law to register using the know-your-customer (KYC) procedure.
On both DEXs and DEX aggregators, this is not necessary because the entire protocol is automated and, you guessed it, decentralized.
Top DEX Aggregators
To connect to any DEX aggregator, one only needs a non-custodial wallet like MetaMask. All DEX aggregators have nearly identical interfaces. With all things equal, it would be prudent to check each one to see how well they match specific trade orders. After all, this is dynamic because DEX liquidity depends on user involvement and market conditions.
1inch — by far, this DEX aggregator has the largest number of token pairs, covering the most networks. Up until November 2022, it covered $254B worth of trading volume from 309 liquidity sources.
1inch also has its own token called Chi Token, which can be used to cover for ETH gas fees. Other than that, 1inch doesn’t charge fees for withdrawals.
OpenOcean — among the first DEX aggregators, it covers 18 blockchain networks with over 200 liquidity sources. Moreover, the world’s largest CEX, Binance, also provides liquidity to OpenOcean, delivering low slippage trades for over 143 token pairs.
ParaSwap — a DEX aggregator with its own liquidity pool – ParaSwapPool for extra low slippage measure. ParaSwap covers seven blockchain networks, and it has over 65 liquidity sources.
ParaSwap’s strong point is integration with the most popular DeFi wallets and dApps — Aave, MetaMask, Ledger, Argent, Enzyme, and Zerion.
Paraswap also has mobile versions for Apple users, while an Android app is coming soon. Because this DEX aggregator has its own liquidity pool and PSP token, users can stake them to receive rewards.
DEX Aggregators: Indispensable DeFi Cogs
DEX aggregators are one of those innovations that don’t displace existing dApps, but add another layer to them. By connecting hundreds of DEXs’ liquidity pools, they all but eliminate the key stumbling block of DEX trading — low liquidity resulting in slippage costs.
There is no downside to using DEX aggregators. In fact, one should get in the habit of using multiple DEX aggregators to see which one delivers the best results consistently.
This series article is intended for general guidance and information purposes only for beginners participating in cryptocurrencies and DeFi. The contents of this article are not to be construed as legal, business, investment, or tax advice. You should consult with your advisors for all legal, business, investment, and tax implications and advice. The Defiant is not responsible for any lost funds. Please use your best judgment and practice due diligence before interacting with smart contracts.