Within 24 hours of the oil shock that started from the Iran War, HyperLiquid had $1.2 billion of trading volume for oil futures while primary exchanges were closed. Decentralized Exchanges (DEXs) are one of the, if not the, most fundamental protocol types of decentralized finance. A DEX enables users to swap cryptocurrencies on a decentralized protocol. This is to say someone can trade their USDC for ETH without going to a centralized exchange like Coinbase or Kraken, but they can do anything they need seamlessly on-chain. The most fundamental version of a DEX is what one might understand as the earliest versions of Uniswap, where a pool of liquid crypto assets exists, and people can swap one token for another within that pool. The fundamentals of liquidity and fee generation haven’t been lost to DEXs. However, platforms like HyperLiquid and Jupiter have taken what it means to be a DEX to the next level, and it is important to understand these growing protocols. These developments can be seen through the lens of leading 2 DEXs, HyperLiquid and Jupiter. But first, a short explanation of how a typical DEX works through the lens of Uniswap V2 is helpful.
Uniswap V2 (circa 2020): Uniswap is one of the earliest and most popular DEXs, which is still thriving with very deep liquidity pools and transaction flow. The premise of how this platform works involves two primary parties, liquidity providers and swappers. A liquidity provider is someone who holds extra crypto and wants to earn a fee on their holdings. They would take this crypto to Uniswap and deposit it into a liquidity pool. These pools were separated based on asset pairs like USDC/ETH or BTC/ETH, which meant that in a particular pool, a swapper could swap one of the pairs (USDC) for another (ETH) and vice versa. Liquidity providers earned a fee every time someone swapped within their liquidity pool, and swappers paid a small fee for swapping. These liquidity pools are called automated market makers (AMMs), which have pretty simple math:
x = Amount of Coin X
y = Amount of Coint Y
K = Constant Product
x * y = K
Price of X = K/y
Price of Y = K/x
Each time a person buys or sells, they change the ratio of tokens in the pool and so change the price of the tokens according to the formula. Therefore, a person trading on a AMM DEX is trading against the liquidity pool, not another trader, as most typical financial markets work. This infographic pictures it and shows some more nuances like slippage:
DEXs typically have some more nuanced features than this now, but the fundamentals remain rooted in this idea.
HyperLiquid: HyperLiquid is one of the most popular DEXs right now. Its HYPE token trades at around a $10 billion market cap, which is the 10th highest of all cryptocurrencies. What sets HYPE apart from other DEXs the most is that it runs on its own layer 1 blockchain. The issue with some Ethereum DEXs, like Unisawp is that a transaction of $30 in crypto might end up charging $10 in gas fees, which is totally unreasonable for almost anyone. However, by building their own layer 1 chain and consensus mechanism, HyperBFT, HyperLiquid was able to get rid of gas fees completely. HyperBFT also allows them to process transactions at a much faster rate than Ethereum and even a lot of layer 2 chains. This makes them perfect for their core competency, trading. Most of this trading happens with perpetual options (perps), which are option contracts with no time duration or strike price, essentially making them a way that traders can trade with leverage. Perps have a liquidation price depending on the leverage level. For example, if one puts a long on ETH when it is valued at $2,000, and they have 10x leverage, the liquidation price would be $1800 because a 10% loss * 10x leverage = 100% loss. This is what people mean when they say the crypto market declined due to traders getting liquidated. HyperLiquid still works with the same fundamental liquidity pools as the Uniswap example, with a few nuances. One, there is a main liquidity pool, the HyperLiquidity Provider (HLP), where liquidity providers can only deposit USDC. This enables the traders' activity, and the providers earn fees, which are plentiful because there is no gas fee to compete with. However, this is where HyperLiquid takes its next critical detour. The reason people can only deposit USDC is that HLP is not a traditional AMM. Instead, HyperLiquid runs a central limit order book (CLOB) just as most traditional financial markets do. The HLP is a vault that runs an automated trading system, placing limit orders on both sides of the price to provide liquidity to a market, as quant firms Jane Street and Citadel do in regular markets. With this system, HyperLiquid offers a huge amount of speed compared to other DEXs and gives traders the knowledge that they are trading against people, not a liquidity pool. Overall, HyperLiquid makes real crypto and tokenized asset trading possible compared to traditional DEXs.
Jupiter: Jupiter is the next DEX that shows what DEXs are becoming very well. Jupiter runs on the Solana blockchain, which itself is a fast, low-gas-fee chain. However, it feels unfair to call Juptier a DEX because it does much more than that. Jupiter (jup.ag) has swapping and perpetuals, but it also has lending, prediction markets, a mobile app, wallet services, staking, a stablecoin, and a developer toolkit. When someone looks at Jupiter, it might remind them of how Coinbase is trying to become the “everything exchange,” but from a Web3-first strategy. What makes Juptier special as a DEX is that it is an aggregator for all the DEXs across the Solana blockchain. The nature of AMMs lead to price discrepancies, whether it be slippage because of how well-funded a liquidity pool is, or the automated price for a swap, not all protocols are equal all of the time. Jupiter takes advantage of this by aggregating all the DEXs into their platform and giving the Jupiter user the best terms for their swap by routing swaps to different DEXs. This is super important for Solana because of how fast it is growing, which leads to fragmented liquidity. However, it also appeals to a broader community of people that crave simplicity and aggregation versus the highly fragmented markets of many cryptocurrencies, projects, and protocols.
Overall: DEXs are one of the most important technologies in crypto, and knowing how they work, the pros and cons of them, and how one can interact with them is very important if someone wants to work on-chain. The volume that some are seeing points to very exciting developments for crypto. I think, as these protocols develop better technology and grow more liquidity, institutional investors will be much more inclined to give on-chain crypto a try, but only time will tell.
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