Problems with Exchanges

Centralized exchanges control access to information and order flow. As we have seen many times, this creates misaligned incentives for privileged parties to abuse this control through internalization and Payment for Order Flow (PFOF). In essence, traders are playing against the house. Additionally, exchanges have violated the custody of traders’ assets, repeatedly losing those assets to hacks or financial mismanagement. DeFi was born largely due to the lack of trust in financial intermediaries. Meanwhile, mass market adoption of DeFi has been obstructed by the inability of DeFi to meet the expectations established by the tools of traditional finance. Slippage and front-running create inefficiencies for large traders, and high gas/platform fees make them less accessible for smaller traders. Platforms lack composability, requiring bridges that are susceptible to hacking. Decentralized exchanges cannot compete with centralized and traditional trading without addressing predation, friction, risk, and fragmentation all together. 

The failures of these systems manifest for different reasons, but affect traders similarly: risk is increased, and profitability decreases. Deepwaters combines the best of centralized and decentralized platforms while adding novel functionality to provide a service which is highly efficient, compliant with regulations, yet trustless.

Exchange ComparisonCEXDEX
Zero Gas Trading
Zero Slippage
Zero Front-Running
Zero Payment for Order Flow (?)
Zero Internalization (?)
Zero Rehypothecation (?)
Zero Data Bleed (?)
100% Price Improvement (?)
Fully Transparent
Real-Time Auditing
Self Custody

Table of Contents

    • Poor Execution

      Centralized Exchanges

      Ever feel like your orders only get filled when the market is moving against you? That is adverse selection, which is caused by the counterparties you are trading against having advantages in speed and information - privileges often given to them by the exchanges you are trading on.

      Decentralized Exchanges

      Slippage results in poor execution, often at a price which is not known until after the transaction occurs. This is captured in DEX user interfaces as “slippage tolerance.”

      OUR SOLUTION

      Deepwaters uses a traditional order book, allowing limit orders at a known price. Our secure trading enclave ensures that no party - including Deepwaters itself - can see or act on orders until they are either filled or hit the public order book. This ensures that no party can have an unfair advantage over another.

    • Orders Subject to Predation

      Centralized Exchanges

      Most securities regulations do not apply to licensed cryptocurrency exchanges. They therefore have the freedom to do as they please with your orders - including sell or internalize the order flow, resulting in more profit for the exchange and their trading partners, but preventing your order from hitting the order book to ensure it receives the best possible price.

      Decentralized Exchanges

      Large transactions are subject to front-running, sandwich attacks, and MEV. Transactions afford no privacy, allowing bots to profit from the actions of traders at those traders’ expense. The industry needs to decide if DeFi is something for bots and insiders to exploit, or something that is fair and equitable to all participants.

      OUR SOLUTION

      By storing and processing orders off-chain, but settling those orders on-chain, we create a system that is immune to predation but still trustworthy and auditable.

      Deepwaters will utilize a combination of encryption, hardware-based cryptography, and decentralized blockchain validation to demonstrably prove that the system is behaving as is prescribed by our audited code. This means that no one, not even the platform itself, could alter the order flow. Orders are executed or reach the order book in the exact order they are received. We couldn’t sell your order flow if we wanted to, and you’ll be able to prove it yourself. 

    • High Fees

      Centralized Exchanges

      Centralized exchanges charge low fees, sometimes no fees, but often make up the difference through payment for order flow or order internalization, which causes adverse selection for traders.

      Decentralized Exchanges

      Gas and trading fees limit the viability of small transactions, discouraging participation from smaller-volume traders.

      OUR SOLUTION

      Orders in Deepwaters are efficiently processed off-chain, while still being settled on-chain for complete auditability. Our audited, open-source business rules and decentralized validation of platform operations ensure that order flow is immutable, eliminating adverse selection.

    • Lack of Composability

      Centralized Exchanges

      Centralized exchanges skirt the composability issue by holding custody of all assets, which creates huge risks.

      Decentralized Exchanges

      Cross-chain transfers are difficult, expensive, and unfriendly to the users. Bridges have proven to be points of vulnerability in the DeFi ecosystem, offering large, attractive targets for hackers. Current L0 solutions only address the difficulty; they are still expensive and slow to settle.

      OUR SOLUTION

      Deepwaters uses the fast and inexpensive Avalanche blockchain to maintain state while interoperating with other chains directly for rapid settlement without bridging. Custody on Deepwaters is optional; customers can leave their assets within the platform for faster trades with lower costs, or use Deepwaters in a fully non-custodial manner like a DEX.

    • Custodial Violations

      Centralized Exchanges

      Anyone who needed a reminder of the adage “not your keys, not your crypto” received a stark one from the fall of Voyager. While that degree of gross financial mismanagement is a tail-risk event, it is a potentially devastating one to any unfortunate enough to suffer it.

      Decentralized Exchanges

      Custodial violations are a problem largely unique to centralized exchanges, as almost all decentralized exchanges are non-custodial.

      OUR SOLUTION

      Deepwaters may be used in a non-custodial manner Llike a DEX. If users choose to leave assets inside the platform for convenience, Deepwaters is unable to perform any actions with user assets except those explicitly requested by the user. This is guaranteed by our audited, open-source business rules and real-time, decentralized validation of platform operations.

    • Liquidity Treated as Sacrificial

      Centralized Exchanges

      Centralized exchanges do not use passive liquidity providers.

      Decentralized Exchanges

      Most decentralized exchanges treat the liquidity they are given as sacrificial. Liquidity providers assume risk based on the volatility of the market, but are compensated based on volume. The result is impermanent loss which is often greater than the yields generated.

      OUR SOLUTION

      In Deepwaters, LP’s assets underwrite a range of activities on the platform, such as market making and leverage. Liquidity providers are still rewarded based on volume, however serve a role more akin to underwriters, which mitigates risk, especially over longer time horizons.

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