Can Everyday Traders Trust DeFi’s Automated Market Makers?

This post is part of Consensus Magazine’s Trading Week, sponsored by CME.

In light of the transformative changes in the crypto landscape, the decentralized finance (DeFi) sector has seen an extraordinary rise, followed by moments of decline.

As users grapple with intricate challenges — from managing private keys to navigating various protocols — it’s evident that the simplicity once associated with traditional finance is starkly missing.

Connor O’Shea is CEO at Bril Finance.

Now, DeFi is at a crossroads, and it must overcome these obstacles and embrace a renewed emphasis on simplicity, optimization, and performant returns.

Obstacles limiting the potential of DeFi

One of the major concerns in this DeFi landscape is its volatility, which isn’t just confined to fluctuating asset prices; it’s deeply entrenched in the ecosystem, as illustrated by mercurial total value locked (TVL) in DeFi. The rise to $212 billion in TVL — followed by a precipitous drop to $43.45 billion within a year — is a testament to crypto’s inherent instability.

Amid these dynamics, the challenge of direct liquidity provision rears its head. Traders who venture into open platforms like Uniswap, hoping to capitalize on liquidity provision, often grapple with impermanent loss. This is a phenomenon where traders can end up with lower returns due to asset price fluctuations or negative yields.

Centralized exchanges (CEXs) have had their share of controversies, too. Recent events, such as troubling data breaches at Gemini and the collapse of FTX, have eroded trust in CEXs. Such incidents have inadvertently thrust DEXs into the limelight as viable alternatives (underscored by a significant 24% surge in DEXs following the collapse of FTX).

As DEXs capitalize on this momentum and fear, they’re faced with the limitations of automated market makers (AMMs), the most common type of architecture supporting decentralized exchanges. While AMMs have been instrumental in the DEX revolution — allowing liquidity provision without traditional order books — they are fraught with challenges.

New users often find AMMs non-intuitive and difficult to navigate, especially when dealing with highly volatile trading pairs. To truly challenge CEXs, DEXs need to integrate advanced order book models that complement on-chain smart…