New Generation Of Order Book DEXs Aim To Disrupt On-Chain Trading (2024)

Ethereum’s growing Layer 2 ecosystem wants to disrupt the DEX sector, with Base and Matter Labs looking to host a new generation of decentralized exchanges powered by the limit order books familiar to traditional exchanges.

Base, the forthcoming L2 from Coinbase, has published an open invitation for developers working on limit order book (LOB) DEXs to join its ecosystem.

“Trust in centralized exchanges took a hit following the collapse of FTX,” Base said. “With the rise of Ethereum L2s like Base, it’s finally possible to have the throughput needed for a more advanced exchange while also eliminating counterparty risk through self-custody.”

The push to bring LOB-based trading on-chain comes as confidence in centralized exchanges is at a low following the spectacular failure of CeFi institutions during the 2022 bear market. Assets that users entrusted to third-party exchanges are now tied up in complex legal proceedings, with many investors realizing significant losses.

Binance, the world’s largest crypto exchange, was sued by the CFTC just last week.

“Decentralized LOBs are permissionless and far more transparent than centralized competitors,” said Jay Jog, the co-founder of Sei, a Layer 1 blockchain intended to host LOB-based exchanges. “LOB-based DEXes can offer unique order types to users and more advanced trading methods that are more common in traditional finance.”

Automated Market Makers

The decentralized exchange sector is currently dominated by the automated market maker (AMM) model. AMMs host liquidity pools through which traders can permissionlessly execute trades. Liquidity providers supply assets to the AMM, earning trading fees in exchange for taking on the risk of divergence loss.

However, AMMs suffer from poor capital efficiency, offer limited trading techniques, and imprecise estimates for settlement prices, meaning many sophisticated traders are willing to accept the custodial risks associated with centralized exchanges to trade using a limit order book.

Base emphasized the potential for LOBs to bring professional traders and institutions on-chain. “We’re really excited about builders exploring the full design space of how exchanges can be built on-chain,” Jesse Pollak, head of Base, told The Defiant.

Oracle Infrastructure

Base may face stiff competition from Matter Labs’ rival Ethereum L2, ZkSync Era.

Marco Cora, head of business development at Matter Labs, told The Defiant that Era boasts a unique oracle design suited to enabling LOB-based trading on-chain. While most networks charge users every time an oracle is updated, Era allows oracles to update as many times as desired within a single block without incurring additional fees.

In theory, the system would allow traders to cheaply place and update limit orders with high frequency, eliminating one of the barriers to on-chain LOB-based trading.

Comparable User Experience

Sam Xiao, Matter Labs’ DeFi business development lead, told The Defiant that LOB DEXs must offer a comparable experience to centralized exchanges to compete at scale, including “allowing flexibility with pricing and order sizes.”

“The tricky part is minimizing the current inefficiencies so they don’t get arb’d to death or deal with toxic flow,” Xiao said, adding that many of the challenges facing LOB DEXes must be ironed out through trial and error.

Xiao noted that several teams are already working to build LOB-based DEXes on Era, including Dexchange, PerpDEX, Izumi, Mes Protocol, and Clober.

Sei Aims to Build LOB Infrastructure

Sei, an upstart Layer 1 network, believes LOB DEXes need bespoke blockchain architecture to realize their full potential.

Sei claims to be “the first sector-specific Layer 1 blockchain” built to facilitate on-chain LOB exchanges.

Jay Jog, the co-founder of Sei Labs, told The Defiant that Sei offers a customizable order-matching engine, order bundling to protect against MEV, and fast finality to support LOB protocols.

“LOBs have the potential to provide less slippage, a better user experience, and more advanced trading options for users compared to the current generation of AMM DEXes,” Jog said.

Existing Order Book Solutions

While the likes of Base, ZkSync Era, and Sei hope to host new LOB-based protocols, solutions already exist allowing users to place limit orders on DEXes.

In June 2021, 1inch, a popular DEX aggregator, launched its Limit Order Protocol, allowing users to place limit orders on-chain. The protocol attracted more than 20,000 users and facilitated 60,000 trades worth $2.9B.

Speaking to The Defiant, Anton Bukov, the co-founder of 1inch, highlighted the improved capital efficiency of LOB trading compared to AMM-based decentralized exchanges.

“LOB-based DEXes could have more liquidity and offer better prices due to higher capital efficiency,” Bukov said. “For some users, limit orders are preferred, especially for large orders.”