Yellow Network
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Whitepaper

Yellow Network Technical Paper
This Whitepaper is currently undergoing modifications and as a result, some content shown below might be outdated and/or not in line with other sections in the Gitbook. We will inform the community about the launch of the new Whitepaper in due course.

Abstract

The cryptocurrency ecosystem has been plagued by a lack of scalability and interoperability, primarily due to blockchains and exchanges that function in fragments of protocols. This has led to the isolation of liquidity and resources among different blockchain layers and exchanges.
However, with the introduction of Yellow Network, things are about to change. Yellow Network introduces a new generation of state channel-based financial information exchange (FIX) communication systems between exchanges, brokers, and trading firms to enable truly decentralized trading and make Web3 a reality.
Yellow Network leverages Layer-3 protocol to create the first-ever decentralized broker clearing network that operates on state channel technology. With Yellow Network, two things are possible: users can kickstart their profitable exchange platform with liquidity supplied and shared by the network, and are able to reduce trading fees considerably by holding $YELLOW tokens. This became necessary because the current monolithic business structure of today’s crypto exchanges isn't scalable and they do not interoperate with each other.

Introduction

The usage, adoption, and application of cryptocurrencies and their prices have increased gradually over the past few years, allowing the cryptocurrency asset class to attract institutional investors and continue to gain popularity. As a result, the businesses in the sector have likewise seen a period of continuous growth. Cryptocurrency exchanges in particular have seen sustained growth in recent years. With the exponential growth of cryptocurrency assets, it's unsurprising that trading this asset class has become a public fascination.
For a variety of reasons, both retail and institutional investors are increasing their exposure to cryptocurrencies through diverse strategies such as ETFs and derivatives trading. Many of these investors were seeking a safe haven from inflationary fiat currency. They hedged assets that are uncorrelated with the price movements of typical financial products such as stocks or bonds. The cryptocurrency market reached a record high of $3 trillion in November 2021, when the world's two major cryptocurrencies, Bitcoin and Ethereum, rose to record highs and rallied more than 6% to reach $67,591.86 and 3.5% to reach $4,789.45, respectively.
Source: Statista - Overall cryptocurrency market capitalization per week from July 2010 to May 2022 (in billion U.S. dollars).
Currently, the cryptocurrency market capitalization has been rallying at around $2 trillion, as can be seen from the graph above. One of the major drivers of this growth in the adoption and usage of cryptocurrency has been the cryptocurrency exchanges. Cryptocurrency exchanges are platforms that allow for the trading of cryptocurrencies for other asset classes, such as fiat and digital currencies. Data from CoinMarketCap shows that there were 521 cryptocurrency exchanges as of May 2022, of which 306 were centralized exchanges (CEXs), and the remainder were decentralized exchanges (DEXs), derivatives, and loan markets.
Source: Chainanalysis - Number of Active Cryptocurrency Exchanges by Month from January 2019 to July 2021.
One thing stands out among the growth of cryptocurrency exchanges and projects. Each of these platforms leverages a different blockchain protocol, performs different transactions and operations, and processes a unique volume of data. Likewise, it is becoming increasingly evident that their operations are siloed. Furthermore, the rapid growth of blockchain technology has resulted in the emergence of various chain configurations.
The siloed structure in the cryptocurrency industry has stalled scalability and is threatening the core fabric of the cryptocurrency ecosystem. This problem is exacerbated by the fact that there currently exist more than 18,000 cryptocurrencies as of March 2022, with many of these cryptos using their proprietary blockchain protocols. One factor contributing to the complexity of cryptocurrency trading is the sheer number of blockchains and exchanges involved. For instance, if a user wishes to transfer 10ETH that exists on the Ethereum blockchain (ERC-20) to the Avalanche network, the user may be required to pass through many processes and steps to get AVAX tokens on the Avalanche network. This approach, particularly for inexperienced users, may involve considerable time spent looking for and evaluating decentralized finance (DeFi) tools and platforms to find the one that best fits a particular scenario. Experienced users will also need to factor in tracking wrapped token blockchain gas fees and navigating a lot of user interfaces.
Additionally, both centralized and decentralized exchanges suffer from insufficient liquidity, which is spread across dozens of different marketplaces and exchanges that are compelled to compete. Each new blockchain project adds to this instability and greatly slows the crypto industry's growth and scaling. The exchange landscape faces massive challenges that have become difficult to overcome. The following are the prominent challenges faced by the crypto ecosystem today.
Source: Statista - The biggest problems that cryptocurrency traders see in currently available exchanges.

Cross-Chain Transactions

Cross-chain interoperability is in demand and is a vital component of the success of several blockchain projects. Since the inception of open-source cryptocurrencies with Bitcoin in 2009, the number of blockchain networks with diverse designs and functionality has exploded. As the blockchain community has grown exponentially, financial information communication and data interchange across networks has become increasingly difficult.

What is a cross-chain?

A cross-chain is the capacity of two relatively independent blockchains to communicate with one another. Cross-chain implementation is primarily represented by asset swapping and asset transfer, both of which are critical components of the blockchain ecosystem. Cross-chain communication and transaction can be divided into Isomorphic and Heterogeneous, depending on the underlying technology.
For cross-chain transactions to occur, there are unique approaches to achieve interoperability across different chains:
  • Atomic swaps
  • Federations
  • Stateless SPVs
  • Relay
Despite the critical nature of blockchain interoperability, cross-chain systems still face several hurdles when it comes to transacting assets or data between chains. These difficulties include transaction rate bottlenecks and disparities in trust.
Yellow Network builds on the development work of the current system by pooling liquidity from different chains using cutting-edge state channel technology to enable fast trading and reaching assets locked on isolated networks without directly bridging them. By leveraging state channel technology, users can trade across many blockchain ecosystems, increasing liquidity, asset diversity, and trading volumes, and growing the market for cryptocurrency. Cross-chain protocol leveraging state channels became necessary for the crypto market to fully use the power of interoperability and liquidity across different chains.

State Channels

Scaling is perhaps the most significant roadblock to the widespread usage and adoption of blockchains and cryptocurrency today. While some programs are thriving, the majority are still too slow and costly for average consumers.
​State channels improve public blockchain throughput by reducing the computational load placed on nodes when processing and storing transactions. This makes it easy to run a node, which decentralizes the process of certifying the miners' work.
State channels, meanwhile, lower the costs associated with using the blockchain network. Rather than paying transaction fees, users only pay for gas when they open and close a channel. Additionally, state channels aid in the preservation of user privacy. Transactions within a channel are known only to the channel's members. This contrasts with transactions on the Ethereum blockchain, which record each transaction in a publicly auditable ledger. Finally, transactions within state channels achieve instantaneous completion. Users do not need to wait for each transaction to be confirmed on the blockchain, as each signed transaction complies with the network's regulations. This creates a more seamless user experience and more closely resembles how popular web applications operate now.
Source: Blockchainhub Berlin​
While most traders only use CEXs (Centralized Exchanges), the trading occurs in isolated silos; each CEX and DEX (Decentralized Exchange) has its own list of markets and, unlike traditional finance, those markets are not global.
Blockchain has brought decentralized computation, but it's far from being able to scale to what traditional finance is today, due to the consensus algorithm which requires nodes to agree on the version of the state.

Background

Cryptocurrency trading is now a reality and is enjoying a fast rate of user adoption all over the world. Since Bitcoin many alternative projects were launched, and users have now a large choice of different blockchains and many decentralized applications. New challenges appear to simplify the user journey in this wild wide web 3.0. Bridges are one of several technologies brought to interconnect blockchains; they arose from a lack of decentralization, ERC20 native connection from one to another chain, and a need of large liquidity for many tokens on every chain to satisfy the user demand.

Centralized Exchange

Security concerns
Centralized Exchanges are fully in charge of the deposited users' assets. It means users have to fully trust them to secure platform wallets correctly and process trades in fairly manner. Security has been taken seriously by the big exchanges recently, but it comes at a great cost; however, we still read of exchanges being hacked and users' funds being drained by attackers. Most small exchanges can't afford the cost of securing correctly users' funds.
Support of blockchains
To keep a Centralized Exchange running involves multiple operations. We just mentioned the security aspect which require a full-time focus by a dedicated team. Supporting many blockchains is also extremely complex and expensive. Each one needs to be monitored specifically to make sure nodes and platform applications stay synchronized and process blocks in real time. The load of some chains sometimes jumps quickly with the cost of transactions, which can lead to withdrawals not being processed or only very slowly. Overall, the gas price for withdrawals, transactions, and deposits processing might have to be adjusted frequently.
Compliance
For an exchange to comply with local regulations can be very complicated. Small exchanges will probably prefer to target a single market and comply with a single regulator. Another approach is to simply register the company in a country where they can operate without any regulation; this solution exposes users to the goodwill of the platform operator, regulator rules being usually made to protect customers.
Market making & Access to liquidity
Running an exchange with many markets imposes the need to maintain order books with tight spreads in order to provide the best offers possible to users. It also requires deep liquidity in the order book to avoid big price moves in the event of sporadic high demand on a market.
Centralized Exchanges usually delegate this duty to "market makers." This service can be very expensive and the exchange might still have to provide a large proportion of the liquidity to be injected in the order book.

Uniswap: A Short History

Uniswap is a decentralized exchange application, launched in 2018 [@uniswap-history]. It was the first DEX to gain a significant traction on the Ethereum mainnet by August 2020. Since then many clones and other decentralized applications were launched on multiple blockchains and used by millions of users to swap tokens, lend or borrow cryptocurrency assets, bridge funds between blockchains, and many more use cases.
Uniswap paved the way of DeFi (Decentralized Finance).

Security, Auditability

This brought many advantages compared to centralized exchanges. The exchange software is fully implemented in smart contracts that are deployed on the blockchain, thus anyone can read how it works. Many audits were performed by independent parties, many DeFi applications were left with breaches and funds were exploited, but over time the security of those applications tends to be proven.

Automatic market making

Anyone can provide liquidity to Uniswap markets ("pools") and receive a revenue share from fees collected during trading ("swaps"). Moreover, the price of assets is managed automatically; every trade impacts the price up or down depending whether it's an ask or a bid. Since Version 1 the protocol evolved to be more resilient in v2 and to use liquidity more effectively in v3 [@angeris2020improved].
Uniswap protocol provided an elegant solution to the problem of market making and access to liquidity.

Performances

The success of those applications led to traffic jams in the Ethereum network, and the cost of transactions has been growing to reach unsustainable levels. DEX and DeFi applications are facing the limitation of blockchains' throughput. Many projects claim to solve the problem of blockchains' scalability; some dramatically improve the throughput of transactions, like Polygon or Solana.

Front running bots

The transparency of blockchain transactions and the fact that Ethereum order transactions by gas price exposes users of DEXs to front-run bots [@daian2019flash].
Such bots monitor the blockchain and the in-memory transactions pool (containing transactions not yet mined in a block) for incoming swap transactions. They check slippage tolerance allowed by the user, calculate the cost of front-running transactions, when profitable they execute a transaction just before the user by setting a higher gas price, and finally a transaction just after the user to take the profit.

Compliance with local regulations

Decentralized applications are accessible by everyone on the planet the same way, without any difference between users. This feature allows anyone to access cryptocurrency wallets and use these solutions, giving people who can't open a bank account access to cryptocurrencies and decentralized finance.
Nevertheless, each country has specific regulations in place applied to financial products, thus these fully open and restrictionless solutions are violating those rules.

Lightning Network [@poon2016bitcoin]

Lightning Network is a Layer-2 solution for the Bitcoin network. It was proposed as a solution to Bitcoin's scalability problem. It leverages state channel technology to be used as payment channels to perform any number of off-chain transactions. A payment channel is initiated by an on-chain funding transaction, followed by any number of off-chain transactions. Finally, to commit balances a settlement transaction is performed on-chain. While Lightning Network introduce real-time fund transfer in blockchain, our protocol leverages the same technology for high frequency trading.

DyDx [@juliano2017dydx]

DyDx is a trading platform of derivatives markets. It combines the speed of centralized order book and the transparency of decentralized applications. The result is a more secure and faster software architecture; the downside is that it's limited to Ethereum's users.

Qredo [@mccuskerqredo]

Qredo focuses on securing digital assets using MPC [REFERENCE NEEDED], eliminating the sensitive private key from the signature computation. It also allows settlements by updating an internal ledger entry without costly transaction on the blockchain [TO BE CONFIRMED]. While Qredo brings state of the art security for digital assets, it doesn't facilitate high frequency trading.

LayerZero

LayerZero provides an SDK which enable cross-chains transactions, but it needs to modify existing smart contracts and doesn't solve performance issues; it actually increases the numbers of transactions on already congested chains.

Design

Mesh network

Network participants

Retail brokers

A small exchange, located on a specific country or region, complying with local regulations. In our network we define brokers as non-custodial businesses.

Market makers

Market makers provide liquidity to the network; they create and maintain open orders to allow users access to the best offers possible. They receive a fee from trades.

Exchanges

Exchanges are big players of the network; they usually target a global audience and are regulated in many different countries. They can list tokens exclusive to the network and bring in market makers. They can also manage themselves via the platform's custody. In short, those actors manage all the roles of network participants. They don't absolutely need to connect to other brokers, but it can only be better for their customers to bring more liquidity and offers on markets.

Custodians

Custodians are in charge of holding customers' funds securely. Additionally, they allow the broker to easily connect to multiple blockchains, depending on their current supported blockchains.
We plan to support the following custodians as a start:
  • Qredo
  • Cobo
  • Fireblocks
  • Gnosis safe (decentralized)

System components

Network nodes

Network nodes are operated by brokers. They have local markets and their own connections to blockchains and custodians; they interconnect with different brokers to bring liquidity to their markets.

Adjudicator

The adjudicator is a smart contract used by brokers to validate a settlement. It verifies that the last state transition is valid and signed by both brokers. Being a smart contract it ensures brokers of transparency and that the rules won't change over time without both parties agreeing to upgrade to a newer version of the protocol.

Custodian

Custodians are responsible for holding users' funds securely. They can be an external provider or a smart contract. Custodians use a set of rules to release funds. Each one can provide a different set of features to increase fund security; they make sure the user requesting a withdrawal is the real initiator of the request and didn't perform any kind of fraud.

Protocol

Yellow Network allows brokers to pair liquidity from one to another. A broker pairing with another broker on a market will display orders from the other broker in his order book, extending his offering and increasing the overall liquidity available for his users. When a user takes an offer coming from another broker, they exchange liabilities using state channel protocol to ensure both agree on the accounting change. Later a settlement process can be initiated by any broker to lower their risk and move partial or all funds owed from one to the other.

Collateral

Both exchanges have to lock a collateral in order to guarantee they are solvable for the other peer. Different currencies can be used as collateral; a mix of stable coins and major cryptocurrency tokens is probably a good choice for the platform in order to keep a relative stability of this collateral value while the market swings.

B2B (Broker to Broker) liquidity channel

Brokers use a state channel protocol [@perun2] to keep track of assets owned from one broker to another. This technology allows a secure track of funds without the need of on-chain transaction for every trade. It makes the trading process between two brokers very fast and secure.
To open a state channel, brokers need to agree on the amount of YELLOW tokens to be used as collateral. Once they have an agreement on the amount and they both deposited the tokens, the state channel is active and they can start trading.
State definition:
Field
Protobuf type
Description
chain_id
uint64
Identifier of the blockchain on which the application is deployed
participants
repeated string
Brokers' addresses
channel_nonce
uint64
Unique identifier of the channel for all participants
app_definition
string
Address of the smart contract of the adjudicator application
challenge_duration
uint64
​
app_data
bytes
See below the definition of the app_data for Yellow Network liquidity channel
outcome
bytes
​
turn_num
uint64
Turn number: incrementing at every turn, this allows the easy identification of the latest version of a state
is_final
bool
Once true and signed by all participants, the channel is closed and the final outcome can be applied on the blockchain safely by any participant

Remote order matching

When a user order matches an order from a peer-broker, the platform will use the active state channel with the peer to perform the trade and account the liabilities of one broker to another.

Settlement

Every once in a while brokers will perform a settlement process to finally transfer assets owned to each other. A settlement process can be triggered by any broker at any time. A broker can decide to settle if they need some asset liquidity; to honor a withdrawal request, for example. Another reason for triggering a settlement is the value of assets being held from one to another becoming unbalanced. If the difference in assets value between two brokers reaches the value of the collateral, it's getting urgent for one of the brokers to trigger the settlement.

Multi-chain & Multi-custody support

The broker can connect to many custodian solutions, each custody solution having a different list of supported blockchains. The broker will benefit from other supported blockchains managed by his custodies. Once connected to a custody, users will be able to deposit and withdraw funds from all supported blockchains.

Comparison

Criteria
Existing solutions
Yellow Network
Speed
CEX: 50-450 ms DEX: 30-120 sec
You have the lowest latency at any point on the globe: 10-50 ms
Liquidity
Fragmented and in competition for stacking
Aggregated without locking requirements; you can mine trading fees without unstacking your assets
Cross-chain
Using bridges, extremely high risk and slow
Through Layer-3 Virtualization, off-chain assets can remain in cold wallets but traded at low costs
Decentralization
CEX: Are centralized in a data center. DEX: Are located on a single chain
High, true decentralization of business, data centers, and chains
Table: Benefits of solution

Finance

ECN

An electronic communication network (ECN) is a computerized system that automatically matches buy and sell orders for securities in the market. ECN trading is especially helpful when investors in different geographic areas wish to complete a secure transaction without the use of a third party.
ECN facilitates access to brokers to global financial markets; Yellow Network protocol forms a decentralized ECN for digital assets.

Clearinghouse

A clearinghouse is a financial institution formed to facilitate the exchange securities, commodities, or derivatives transactions. The clearinghouse stands between two broker firms to reduce the risk of a member firm failing to honor its trade settlement obligations.
The clearinghouse enters the picture after a buyer and a seller execute a trade. Its role is to accomplish the steps that finalize, and therefore validate, the transaction. In acting as a middleman, the clearinghouse provides the security and efficiency that is integral to stability in a financial market.
Facilitates cross brokerage transactions; Yellow network brings this functionality using state channel technology and settlement using a smart contract.

Cross-currency swap

A cross-currency swap (XCS) is described as a derivative contract, agreed between two counterparts, which specifies the nature of an exchange of payments benchmarked against two interest rate indexes denominated in two different currencies. It also specifies an initial exchange of notional currency in each different currency, and the terms of that repayment of notional currency over the life of the swap.
Text
Number of tx
Value per tx
Frequency
Network
Trading
High
Low [$100 - $1,000]
500-1000 times per second
Layer 3
Clearing
Medium
Medium [$10,000 - $100,000]
Daily
Layer 2
Settlement
Low
High [$100,000 - $1,000,000]
Weekly
Layer 1
Table: Decoupling trading, clearing, and settlement

Conclusion

Yellow Network is an overlay mesh peer-to-peer (P2P) network that uses state channels to connect all blockchains, allowing it to reach any token locked in isolated networks without the need for cross-chain bridging.
Yellow Network matches throughput averages in billions of messages per day, which is far quicker than any Layer-1 and Layer-2 solution currently available. Yellow Network is basically an automated smart clearinghouse, comparable to the manual clearinghouses used in conventional finance, that acts as a mediator between brokers. The Network provides users with a protocol that works worldwide, an all-in-one toolset, and a Web3 solution ready for the mature retail global finance market by offering real-time inter-broker exchange, near-instant off-chain transactions, and efficient on-chain transactions.
Yellow Network leverages state channel technology to revolutionize trading cryptocurrency through decentralized broker clearing networks. By decoupling trading and settlement, the Yellow Network protocol enables true decentralization of high-frequency trading and widens access to a great variety of assets, including digital and traditional assets.

References

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