As crypto investors shift to non-custodial trading platforms, decentralized exchanges continually experiment with new methods to manage trades and enhance security, user experience, and cost efficiency.
The primary liquidity models are strategies used by decentralized exchanges to handle users’ trade requests and execute asset swaps efficiently. How a Dex manages liquidity and handles trade requests is essential to its general operation.
Key Takeaways
- Decentralized trading platforms use different models to create a liquidity layer for traders to execute trades freely. Popular models are the Order Book, AMM, and Peer-to-pool liquidity models.
- Order Books are similar to centralized exchange trading engines, while AMM Dexs use liquidity pools and an Automated Market Market to serve traders. The Peer-to-pool or intent-based model gamifies trading on a Dex
- Each model scores a point in terms of usability, security, and cost-efficiency. In this article, we review and compare the three major liquidity models used by centralized exchanges.
Liquidity models contribute significantly to an exchange’s cost-efficiency, security, privacy, and overall user experience.
AMM Dexs are unarguably the most popular, but other liquidity models are rising to fame. First, let’s understand the primary liquidity models used by contemporary decentralized exchanges.
Understanding the Different Decentralized Exchange Models
Here, let’s explain the different Dex liquidity models.
1. Order Book Model
The order book model is similar to the trading system used on centralized crypto exchanges. To create an order, users specify their trading terms (the amount they wish to swap and the desired price they want their order to be settled).
A central order book holds trade requests created by users and matches the trades using a price and time priority-based system. That is, it displays the highest bid and lowest ask prices at the top, and executes trades automatically when orders are matched. This model is used by Dexs like Serum (on Solana), Orderly Network, WOOFI DEX, and JUMP Dex.
2. AMM model
The AMM model is an older liquidity model used by Dexs like Uniswap, Curve, and Balancer. The AMM liquidity model is powered by a liquidity pool and a matching algorithm (Automated Market Maker). The Liquidity pool is a smart contract that holds the assets in a trading pair.
Liquidity providers supply resources that enable the protocol to work by committing an equal amount of the assets in the liquidity pair to the pool. When a trader creates a trade request, the AMM executes the trade by swapping the provided asset with the counter asset in the pool.
The AMM adjusts the value of the paired asset according to the demand and supply conditions. AMM model, however, exposes liquidity providers to risks like impermanent loss and technical exploits.
3. Peer-to-pool (intent-based) model
The Peer-to-pool model is a more gamified trading model. It is also known as the intent-based or solver-based model. Here, a trader’s order is known as an intent. The intent specifies the asset they wish to trade, the amount, and the price they wish to trade at.
This intent is broadcast to solvers (a network of third parties that compete to execute trade requests) on the network, who attempt to achieve the trader’s goal (provide the resources to complete the trade).
Solvers analyze various liquidity sources, including DEXs, CEXs, and private order books, to determine the most efficient execution path to complete the trade. Solvers consider cost-efficiency (gas fees), liquidity depth, and best price.
Order Book vs. AMM vs. Peer-to-Pool DEX Models
Here’s a tabulated summary of the differences between Order Book, AMM, and Peer-to-Pool DEX Models.
| Parameter | AMM Dex Model | Order Book Dex Model | Peer-to-pool Dex Model |
| Mode of Operation | AMM executes trade requests using assets in the liquidity pool | The central order book holds users’ orders and executes them by matching trades accordingly | Traders create an ‘intent’; Solvers execute the trade by satisfying the intent |
| Blockchain-level interaction | Fully on-chain | Off-chain order book, on-chain settlement | Off-chain intent, on-chain solvers and execution |
| Gas Costs | High gas costs due to multiple blockchain interactions | Relatively low gas cost | Relatively low gas cost |
| Speed of execution | Transactions are executed at the speed of the blockchain | Transactions are executed when there is a matching trade | Relatively fast, as the solver’s network competes to execute orders |
| Capital Efficiency | Low in earlier AMM versions, improved in AMM V3 | High. Exact trade requests are executed at preferred prices. | Very high. Solvers can source liquidity from anywhere, often beating the AMM price |
| Source of Liquidity | Liquidity Providers | Onchain Market Makers | Solvers (also known as fillers) |
| Most suitable for | Retail traders, small to medium volume asset swaps | Professional traders, high volume swaps, decentralized derivative trading | High volume swaps. |
| Used by | Uniswap, Balancer, PancakeSwap, Curve Dex | dYdX v4, Hyperliquid, Drift (perps); Injective, Orderly network. | CoW Swap, 1inch Fusion, Across+1inch, Odos, OKX DEX |
| MEV and front-running risks | Very High as trades are visible on the mempool | High in fully on-chain versions; reduced in off-chain + ZK models like dYdX V4 | Very low as Intents can include Dutch auctions, batching, or private mempools that protect users from MEV bots. |
Factors to consider while choosing a Dex based on the Liquidity model
The Liquidity model used by a decentralized trading platform may significantly impact the outcome of your trader. It is therefore important to consider a few factors before choosing a Dex based on its liquidity model. Some of the factors to consider include;
1. Personal trading strategy
AMM-based Dexs are optimal for traders who only wish to swap small to medium-sized volumes. However, if you are a professional trader who regularly trades large volumes and wants tighter spreads for decentralized derivative trading, the Order Book model works best and offers better liquidity and lower slippage.
Regular decentralized exchanges are implementing intent-based models for routine swaps, which also offer a better user experience.
2. Cost-efficiency
AMM-based exchanges are relatively more costly than other models. This is because of the multi-level blockchain-level transactions that attract gas fees and higher slippage, which increases the cost of each trader.
The intent-based model handles gas costs more efficiently and offers a better cost-to-value ratio. The order book model is also relatively cheaper. You can consider both models if you prioritize cost-efficiency in your trade.
3. Liquidity
Liquidity constraints on AMM-based Dexs may result from a limited number of liquidity providers and insufficient resources in the pool. If you trade large volumes, it is important to consider the capacity of the pool.
When using Intent-based and order-book decentralized exchanges, your trades are executed at stipulated conditions. These models, therefore, offer less slippage due to better liquidity.
4. Security and Privacy
Privacy solvers maintain transaction privacy for Peer-to-pool Dex models. However, for personal transaction privacy, AMMs may be the go-to model for retail traders. While your transactions are visible in the mempool, they are executed instantly. Order Book and Intent-based models keep a transparent record of your orders until they are executed.
5. Blockchain network
AMM-based decentralized exchanges are popular on Ethereum and Base network, while networks like Sei and Solana have more Dexs like Serum that use Centralized Limit Order Book (CLOB). For networks like Ethereum, liquidity and trading conditions may be better on AMM-based Dex as they have higher adoption.
Conclusion
DeFi enthusiasts are conversant with the AMM model. Most early Dexs, lending protocols, and Perps trading platforms use the AMM model. However, the Order Book models and the intent-based models discussed in this article also offer several advantages.
As a trader, the essence of this review is to understand how an exchange works and also implement this knowledge in your daily trading activity.
It is recommended that you use a trading platform whose liquidity model serves the highest advantage for your trading strategy. Consider security and privacy as paramount factors; however, cost-efficiency and general user-friendliness are important.
Additional Resource
- https://coingape.com/education/what-are-liquidity-pools-heres-all-you-need-to-know/
- https://coingape.com/education/decentralized-exchange-dex/
- https://www.britannica.com/money/centralized-vs-decentralized-crypto
Disclaimer: This article reviews and compares Dex liquidity models. It intends to educate readers and not offer financial advice. Featured projects are not endorsed. Note that crypto investments carry significant risks.
Source: https://coingape.com/blog/order-book-amm-peer-to-pool-dex-comparison/
