The market challenges Yellow Network seeks to address
Today, the world of cryptocurrency trading shows significant inefficiencies partially due to its decentralized nature. Here at Yellow Network, we are dedicated to tackling some of the deficiencies of the Web3 space.
"The three pillars of blockchain scalability, decentralization and security co-exist but struggle to exist in harmony." - Vitalik Buterin
The so-called blockchain trilemma describes the problem that any project can only prioritize two out of three aspects at any given time.
Based on this theory, the Yellow Network team has identified critical key deficiencies in cross-broker and cross-chain cryptocurrency trading.
Traditional finance approaches this problem by having multiple layers of specialized actors.
On the other hand, crypto markets primarily operate in silos and independent blockchains, leading to a highly fragmented ecosystem.
There are over 200 notable exchanges and over 6000 cryptocurrencies. Around 100 use their own proprietary blockchain, making it hard to achieve secure interoperability.
Despite the critical nature of blockchain interoperability, cross-chain systems still face several hurdles when transacting assets or data between chains. These difficulties include transaction rate bottlenecks and disparities in trust.
These silos and sub-ecosystems hinder scalability, efficiency, and mass adoption.
Traditional finance vs. Crypto finance
Certain scalability projects such as bridges increasingly suffer from fraudulent attacks and exploits. This impacts trust, acts as a major roadblock for many traders, and traps them within chain ecosystems, further hindering scalability.
Market places like centralized exchanges that offer custody provide ease of access, but their custody solutions can put user funds at risk if hacked.
Regarded as the key differentiator between TradFi and DeFi, true decentralization tends to offer one of the biggest headaches in crypto trading. While the underlying blockchain technology per se offers decentralization, trading requires a marketplace. While centralized exchanges offer efficient trading tools and deep liquidity, they are, as their name suggests, centralized and thus controlled by a single entity.
Decentralized solutions, on the other hand, often provide limited functionality, low liquidity, and focus on a specific blockchain ecosystem. Decentralized entities are largely unregulated and have no place of jurisdiction in the case of fraud or misuse, leaving users vulnerable.
Today, most traders use CEXs (centralized exchanges), where trading occurs in isolated silos and within the ecosystem of the CEX. As a result, each CEX and DEX (decentralized exchange) has its list of markets and, unlike traditional finance, those markets are neither global nor aggregated.
Centralized and decentralized exchanges suffer from liquidity spread over dozens of different chains, markets, and exchanges. This forces platforms to choose a set of chains and tokens they work with, ultimately making exchanges competitors and thus fragmenting the market.
Every new blockchain project adds more to this chaos, significantly slowing down the growth and scaling of the cryptocurrency industry.
Many blockchain applications are accessible by everyone on the planet in the same way, without any difference between users. This gives access to cryptocurrencies and decentralized finance products, particularly to those who do not have bank accounts.
Nevertheless, each country has specific regulations applied to financial products and markets; fully open and restrictionless solutions often violate those rules.
Increased attention from regulators worldwide is scrutinizing one of the major beneficial aspects of blockchain technology. Many countries have already started to restrict or even ban access to certain projects and providers, primarily out of fear for consumer protection and the lack of integrity of many solutions.
Centralized exchanges suffer from additional hurdles that can have far-reaching impacts and hinder mass adoption.
Centralized exchanges fully control the assets you deposit on the platform. You have to trust the platform entirely to store your funds securely. We still read about exchanges being hacked and users' funds being drained by attackers. Big exchanges take security seriously, especially recently, but it comes at a high operational cost.
Support of Multiple Blockchains
Supporting a multitude of blockchains on a single platform is complex. Each chain must be explicitly monitored to ensure nodes and platform applications stay synchronized and process blocks in real-time. The load on some chains can escalate quickly, with the cost of transactions increasing rapidly, leading to trades, deposits, and withdrawals not proceeding or doing so very slowly.
Compliance and Regulations
Complying with local regulations can be challenging for exchanges. Small exchanges probably prefer to target a single market and abide by a single regulator. Another common approach is registering the company in a country where it can operate without regulations. While the purpose of regulation is to protect customers, this solution exposes users to the platform operator's goodwill.
In the past, certain exchanges were forced to reduce or even cut user access seemingly overnight due to non-compliance with regulations. This can lead to frozen funds for end-users and potentially result in large losses on open positions.
Market Making and Access to Liquidity
Running an exchange with many markets imposes the need to maintain order books with tight spreads to provide the best offers possible to users. It also requires deep liquidity in the order book to avoid significant price moves in case of sporadic high demand in a market. Centralized exchanges usually delegate this duty to "market makers." This service can be costly, and the exchange might still have to provide a big part of the liquidity injected into the order book itself.
The security, maintenance, and regulatory aspects of a CEX come at a high cost. These costs are usually passed on to the end-user in the form of fees. Some CEXs are publicly listed entities and thus operate "for-profit," which can lead to a conflict of interest between stakeholders and users.
While Decentralized Exchanges mitigate some problems, they raise other concerns.
Blockchain technology is not scaling well. The throughput of blockchains is minimal; users may experience network congestion, resulting in high fees, delays in transactions, or even in transactions being entirely dropped.
Most DEXs only support a single chain, thus restricting the user to a single sub-ecosystem. Trading across different chains by using multiple DEXs, bridges, and wrappers can be costly, slow, and risky.
Although there is an increasing number of DEXs that support multi-chain aggregation, the solutions tend to be far from a lean user experience.
All on-chain transactions are visible publicly before being mined in a block. A bot can "front-run" a transaction by setting a higher gas price, while the user's transaction would execute with a worse price than expected, or risk being rejected outright.
It is too complicated and expensive for the end-user to move assets from one staking protocol to another or from one blockchain to another, requiring as it does multiple complex steps and incurring fees.
Transparency of blockchain transactions and the fact that many chains such as Ethereum require gas fees for transactions exposes users of DEXs to front-running bots.
These bots monitor the blockchain and the in-memory transaction pool (containing transactions not yet mined in a block) for incoming swaps. They check the slippage tolerance allowed by the user and calculate the cost of front-running those transactions. When profitable, they execute a transaction just before the users by setting a higher gas price and finalizing this transaction just after the user executes a trade.
Although those bots do not fraudulently interact with a user's transaction, they distort the market and ultimately worsen the efficiency of the entire ecosystem.
A DEX is not a centralized entity but relies on a trust protocol. Flaws in the protocol can make a DEX vulnerable to fraud and exploitation. Since a DEX is decentralized, there is no entity that can be held accountable in case of wrongdoing, leaving all the risk to the end-user.