Improving the DeFi Trading Experience

On the 5th of March, Pontem hosted a panel discussion at MoveCon featuring industry leaders from Tsunami, and Flow Traders. The topic of the discussion was Improving the DeFi Trading Experience.

You can listen to the full recording on Twitter.

Meet the Speakers:

• Jaden: Investor and business development lead at Flow Traders, a renowned global liquidity provider that focuses on Exchange Traded Products (ETPs) and provides liquidity in digital assets.

• Bones Senpai: Co-Founder of Tsunami Finance, a margin trading and spot exchange that is set to launch on Aptos. Tsunami Finance aims to provide traders with various benefits such as trading with 0% price impact, low funding fees, and low spread.

DeFi's Challenges and Pain Points: An Overview

DeFi has been touted as the future of finance, but it still faces several pain points that are hindering its growth and adoption.

Some of these pain points include:

• Low latency: Low latency creates arbitrage opportunities and, in some cases, even leads to the emergence of miner-extractable value (MEV) attacks which can pose significant challenges to the security and reliability of DeFi transactions.

• Gas costs: DeFi transactions can be expensive due to the gas fees required to process them. The higher the demand for processing transactions on the network, the higher the gas fees can be, leading to significant costs for users.

• Smart contract failure: Smart contracts can sometimes fail or experience performance issues, which can result in loss of funds or other adverse consequences for users.

• Liquidity: The scarcity of market makers in the DeFi ecosystem results in lower liquidity, which can hinder traders from executing trades efficiently, especially for smaller trading pairs.

• Finding Product-Market Fit (PMF):  The DeFi space is highly competitive. Here, attracting users and achieving the right product-market fit is difficult, especially for decentralized exchanges that target retail users.

Barriers to Liquidity in DeFi: Factors Hindering Institutional Traders and Liquidity Providers from Joining the Market.

The DeFi market presents several obstacles that prevent institutional traders and liquidity providers from participating, resulting in barriers to liquidity.

Some of these barriers include:

• Risk appetite for DeFi:

DeFi poses obvious risks, including smart contract risk, counterparty risk, market manipulation, and cybercrime. In 2022 alone, losses from cybercrime in the DeFi market amounted to about $ 2.9 billion. These risks have created significant fear among traders and investors, leading them to switch their risk appetite away from DeFi.

• Regulatory restrictions:

Unlike traditional finance, DeFi remains largely unregulated, making it difficult for institutional traders to comply with regulatory policies.

While the regulatory environment is constantly evolving, and there are efforts to impose stricter policies, the lack of clarity on how to regulate DeFi makes it challenging for institutional traders to navigate this market.

• Lack of risk management mechanism:

The absence of traditional auditing firms that specialize in risk management is another challenge in the DeFi market.

Currently, auditing firms mainly focus on smart contract security, leaving risk management and compliance policies to be largely undefined. This lack of clarity in risk management makes it difficult for traditional traders to participate in the DeFi market.

Mitigating Smart Contract Risks with Move's Security Features

Move Language's distinctive approach to smart contract development instills confidence in mitigating smart contract risks by reducing the vulnerability to reentrancy and other attacks that can compromise the integrity of smart contracts. Additionally, its ability to decompile closed-source contracts streamlines integrations and enhances flexibility for developers.

The integration of advanced security features such as the Move Prover creates an environment that makes it impossible for developers to make mistakes. This serves as an extra layer of protection, which is crucial for DeFi trading platforms where any security breach could lead to substantial financial losses.

Move also offers enhanced security assurances for contract integrations, proiding institutional traders with greater confidence as they connect to Move contracts.

The Need for Clarity in DeFi Regulations

Hong Kong is positioning itself as a hub for crypto and DeFi innovation. The government is currently in the process of setting up a comprehensive framework for centralized crypto exchanges, which will make it easier to regulate these platforms.

However, the major challenge facing regulators when it comes to DeFi is the lack of KYC (know your customer) or customer due diligence. Most DeFi applications are permissionless, which means that users can transact without providing any personal information. This is a problem for regulators who are concerned about preventing money laundering and terrorist financing.

Some DeFi protocols, such as Aave, have already implemented their solutions for KYC, such as permissioned pools. However, there is still a need for a more comprehensive framework that links the identity of the wallet with the identity of the user.

While KYC and AML (anti-money laundering) regulations are important for preventing financial crimes, there is also a risk to users' privacy if these measures are not implemented thoughtfully. If a user's wallet address is linked to their identity, it could potentially open up a huge attack vector for hackers to access their financial information.

One potential solution to this problem is zero-knowledge (ZK) technology, which allows users to prove that they have gone through KYC and AML without revealing any personal information. This could provide a safe way for users to transact while still maintaining their privacy.

Challenges and Opportunities in DeFi Trading for Proprietary Trading Firms

DeFi trading offers many benefits over traditional finance, including greater efficiency, higher yields, and wider spreads. As a result, many traditional financial institutions, prop trading firms, and market makers are taking notice and showing interest in the DeFi ecosystem.

However, as previously mentioned there are still some significant drawbacks that traditional market makers must contend with. Despite these challenges, the potential rewards of DeFi trading are significant.

The previous DeFi summers provided excellent returns on investment, and while yields are currently decreasing, firms are still eager to explore new products that can bridge the gap between retail traders and prop trading firms.

Nevertheless, traditional financial institutions still struggle with:

• Finding capital-efficient ways to participate

While CeFi platforms have more flexible options for lines of credit, DeFi protocols are still largely fixed making it difficult for institutions to negotiate terms.

• Lack of risk profiles:

DeFi protocols do not have an identity mechanism or risk profile system, which makes it difficult to assess risk and determine the quality of users.  

Can DeFi Outperform Traditional Finance? Exploring the Potential for Higher Yields and Increased Capital Efficiency

DeFi has already demonstrated considerable potential in the provisioning of liquidity via automated market makers (AMMs). Remarkably,  even concentrated liquidity pools can be more capital efficient than a central limit order book.

Despite this, traditional trading firms may be cautious in their adoption of DeFi strategies owing to their deep-rooted familiarity with the limit order model and established strategies.

However, the recent collapse of FTX serves as a wake-up call to the potential risks associated with centralized exchanges, making the self-custodial nature of DeFi a more appealing alternative. Moreover, the trustless environment of DeFi ensures that everyone has equal access to opportunities, creating a level playing field for everyone involved.  

DeFi Innovations: Solving Complex Problems with Structured Products and Liquidity Management

One of the most interesting areas of innovation in DeFi is the development of structured products and liquidity management tools.

Structured products are financial instruments that combine different types of investments to create a unique strategy. In traditional financial markets, these products are often complex and difficult to understand. However, in DeFi, teams are creating more user-friendly structured products that enable investors of various risk profiles to participate in the DeFi ecosystem

Additionally, managing liquidity is a crucial element in DeFi protocols as liquidity providers ensure that users can quickly buy and sell assets. Nonetheless, liquidity management can be a cumbersome and time-consuming task. For this reason, many DeFi teams are creating essential liquidity management tools to assist liquidity providers in saving time and effort.

Improving User Experience in DeFi Protocols

Improving the user experience in DeFi protocols is crucial to increasing adoption and enhancing user satisfaction. By implementing these areas for improvement, protocols can make their platforms more user-friendly and intuitive:

1. User Interface:  While many protocols provide a trendy and user-friendly UI, there are still certain things that need to be improved. For instance, when running deeper processes, protocols should provide a more intuitive interface that guides users through the process.  

2. Error Feedback: In case of an error, protocols should provide more robust feedback to users. Instead of simply informing them that something went wrong, they should specify what exactly went wrong and provide clear instructions on how to fix it.

3. Currency Equivalence: There is a need to show equivalence in dollars or other currencies as it would help new users to have a clear idea of how much they are going to spend or how much liquidity they are going to put into the liquidity pools.  

4. Objective Setting: Protocols should allow users to preset an objective before starting a transaction. For instance, if a user wants to do a swap, or add liquidity, they should be able to start with an objective and then proceed with the entire process.

Tokenization of Real-World Assets: The Next Step for DeFi

Currently, a growing number of assets are being tokenized and transferred to the blockchain. Both Maker and Aave have already begun adopting real-world assets and tokenizing them.

The potential benefits of tokenizing the foreign exchange (FX) markets into the crypto ecosystem are significant. The 24/7 settlement of the crypto markets could boost the efficiency of traditional markets, leading to greater yield capture.

Additionally, options are anticipated to emerge in the DeFi space, making it more appealing to market makers and prop traders. These developments could make the DeFi space more attractive and lucrative for these players, driving further growth and innovation in the blockchain industry.

ABOUT PONTEM

Pontem is a product development platform that enables global financial inclusion through blockchain technology. Pontem is developing infrastructure and decentralized tools for the fastest and most scalable Layer 1 blockchain – Aptos.

The Pontem Wallet is the gateway to the Aptos ecosystem available for Chrome,  Firefox, and iOS. Pontem Wallet users can send and receive tokens, connect to decentralized applications, and explore the Aptos ecosystem.

As a result of its partnership with Aptos, Pontem has developed foundational dApps like the Move Playground IDE, Liquidswap AMM, and ByteBabel code translator.