The Underlying Logic of Liquidity Games: From Passive Undertaking to Power Reconstruction

In the cryptocurrency market, retail investors are often seen as the "bag holders" when institutional investors exit Liquidity. When institutions sell off on a large scale, retail investors often passively bear the burden of falling asset prices. This inequality is further amplified in the cryptocurrency space, where the market maker mechanism of centralized exchanges and dark pool trading exacerbate the information gap. However, with the development of decentralized exchanges, new order book DEXs represented by dYdX and Antarctic are redefining the distribution of Liquidity power through innovative mechanisms. This article will analyze how outstanding DEXs achieve physical separation of retail and institutional Liquidity from the perspectives of technical architecture, incentive mechanisms, and governance models.

Liquidity Layering: From Passive Burden to Power Restructuring

The liquidity dilemma of traditional DEXs

In the early automated market maker models, retail investors faced significant adverse selection risks when providing liquidity. Taking a well-known DEX as an example, although its concentrated liquidity design improved capital efficiency, data shows that the average position of retail LPs is only $29,000, primarily distributed in small pools with a daily trading volume of less than $100,000; meanwhile, professional institutions dominate large trading pools with an average holding of $3.7 million, accounting for 70-80% of the institutions in pools with a daily trading volume exceeding $10 million. In this structure, when institutions execute large sell-offs, the liquidity pools of retail investors are the first to become a buffer zone for price declines, forming a typical "exit liquidity trap."

The Necessity of Liquidity Layering

The research from the Bank for International Settlements indicates that the DEX market has shown a clear specialization stratification: although retail investors account for 93% of the total number of liquidity providers, 65-85% of the actual liquidity is provided by a few institutions. This stratification is not coincidental, but rather an inevitable result of market efficiency optimization. A good DEX should manage the "long-tail liquidity" of retail investors separately from the "core liquidity" of institutions through mechanism design. For example, a certain DEX has launched a liquidity pool mechanism that allocates stablecoins deposited by retail investors to institution-led sub-pools through algorithms, ensuring liquidity depth while avoiding direct exposure of retail investors to large transaction impacts.

Technical Mechanism: Build a Liquidity Firewall

Innovation of Order Book Model

DEXs that adopt order books can build a multi-layered Liquidity protection mechanism through technological innovation. The core goal is to physically separate the liquidity demands of retail investors from the large trading activities of institutions, preventing retail investors from passively becoming the "victims" of severe market fluctuations. The design of the Liquidity firewall needs to balance efficiency, transparency, and risk isolation capability. Its core lies in a hybrid architecture that collaborates on-chain and off-chain, safeguarding user asset autonomy while resisting the impact of market volatility and malicious operations on the liquidity pool.

The hybrid model processes high-frequency operations such as order matching off-chain, leveraging the low latency and high throughput characteristics of off-chain servers to significantly enhance trading execution speed and avoid slippage issues caused by blockchain network congestion. At the same time, on-chain settlement ensures the security and transparency of self-custody of assets. Multiple DEXs match trades through off-chain order books and complete final settlement on-chain, retaining the core advantages of decentralization while achieving trading efficiency close to that of centralized exchanges.

The privacy of off-chain order books reduces the prior exposure of trading information, effectively suppressing MEV behaviors such as front-running and sandwich attacks. Certain projects have reduced the market manipulation risks associated with on-chain transparent order books through a hybrid model. The hybrid model allows access to professional algorithms from traditional market makers, providing tighter bid-ask spreads and depth through flexible management of off-chain liquidity pools. One protocol adopts a virtual automated market maker model, combined with an off-chain liquidity supplementation mechanism, alleviating the high slippage issues of pure on-chain automated market makers.

Off-chain processing of complex calculations (such as dynamic funding rate adjustments and high-frequency trading matching) reduces on-chain gas consumption, allowing the on-chain process to handle only key settlement steps. The single contract architecture of a certain DEX merges multiple pool operations into a single contract, further reducing gas costs by 99%, providing a technical basis for the scalability of the hybrid model. The hybrid model supports deep integration with DeFi components such as oracles and lending protocols. A certain exchange obtains off-chain price data through oracles, combined with on-chain clearing mechanisms, to achieve complex functionalities in derivatives trading.

Build a liquidity firewall strategy that meets market needs.

The liquidity firewall aims to maintain the stability of the liquidity pool through technical means, preventing systemic risks caused by malicious operations and market volatility. Common practices include introducing time locks (such as a 24-hour delay, up to a maximum of 7 days) when LPs exit, to prevent liquidity from being instantly depleted due to high-frequency withdrawals. During severe market fluctuations, time locks can buffer panic withdrawals, protecting the returns of long-term LPs, while transparently recording the lock-up period through smart contracts to ensure fairness.

Based on the real-time monitoring of the asset ratios in the liquidity pool by oracles, exchanges can set dynamic thresholds to trigger risk control mechanisms. When the proportion of a certain asset in the pool exceeds the preset upper limit, related trading can be suspended or a rebalancing algorithm can be automatically invoked to prevent the expansion of impermanent loss. Tiered rewards can also be designed based on the LP's locking duration and contribution. LPs who lock assets for a long term can enjoy higher fee sharing or governance token incentives, thereby encouraging stability. A new feature of a certain DEX allows developers to customize LP incentive rules (such as automatic reinvestment of fees) to enhance stickiness.

Deploy a real-time monitoring system off-chain to identify abnormal trading patterns (such as large arbitrage attacks) and trigger on-chain circuit breaker mechanisms. Suspend trading on specific trading pairs or limit large orders, similar to the "circuit breaker" mechanism in traditional finance. Ensure the security of liquidity pool contracts through formal verification and third-party audits, while adopting a modular design to support emergency upgrades. Introduce a proxy contract model that allows vulnerabilities to be fixed without migrating liquidity, preventing the recurrence of significant historical events.

Case Study

Certain DEX v4: A complete decentralized practice of order book model

The DEX maintains the order book off-chain, forming a hybrid architecture of off-chain order books and on-chain settlements. A decentralized network consisting of 60 validation nodes matches trades in real time and completes the final settlement through the application chain only after a transaction is executed. This design isolates the impact of high-frequency trading on retail liquidity off-chain, with only the results processed on-chain, avoiding direct exposure of retail LPs to price fluctuations caused by large order cancellations. The gas-free trading model charges a fee proportionally only after a successful trade, preventing retail users from bearing high gas costs due to frequent order cancellations, thereby reducing the risk of passively becoming 'exit liquidity'.

When retail investors stake tokens to earn a stablecoin yield of 15% APR (from transaction fee sharing), institutions need to stake tokens to become validator nodes, participate in off-chain order book maintenance, and earn higher returns. This layered design separates retail earnings from institutional node functions, reducing conflicts of interest. Permissionless token listing and liquidity isolation allocate the stablecoins provided by retail investors to different sub-pools through algorithms, avoiding a single asset pool being penetrated by large transactions. Token holders decide on parameters such as fee distribution ratio and new trading pairs through on-chain voting, and institutions cannot unilaterally modify rules to harm retail interests.

A Stablecoin Protocol: Stablecoin Liquidity Moat

When users collateralize ETH to generate Delta-neutral stablecoins, the protocol automatically opens a corresponding short position in perpetual contracts for ETH on centralized exchanges to achieve hedging. Retail holders of the stablecoin only bear the yield from ETH staking and the funding rate spread, avoiding direct exposure to spot price fluctuations. When the stablecoin price deviates from 1 USD, arbitrageurs need to redeem the collateral through on-chain contracts, triggering a dynamic adjustment mechanism to prevent institutions from manipulating prices through concentrated selling.

Retail investors stake stablecoins to earn yield tokens, with the yield coming from ETH staking rewards and funding rates; institutions provide on-chain liquidity through market making to gain additional incentives, with the two roles' sources of income physically isolated. Incentive tokens are injected into the stablecoin pool of a certain DEX to ensure that retail investors can exchange with low slippage, avoiding being forced to bear institutional sell pressure due to insufficient liquidity. Future plans include controlling the type of stablecoin collateral and hedging ratio through governance tokens, allowing the community to vote to restrict excessive leverage operations by institutions.

Certain DEX Protocol: Elastic Market Making and Protocol Controlled Value

The protocol has migrated from a certain Layer2 to another cross-chain solution, establishing an efficient order book contract trading model with off-chain matching and on-chain settlement. User assets adopt a self-custody mechanism, with all assets stored in smart contracts on the chain, ensuring that the platform cannot misappropriate funds. Even if the platform ceases operations, users can still forcibly withdraw their assets to ensure safety. The protocol supports seamless deposits and withdrawals of multi-chain assets and adopts a no-KYC design, allowing users to trade simply by connecting their wallet or social account, while also waiving Gas fees, significantly reducing trading costs. Moreover, its spot trading innovatively supports one-click buying and selling of multi-chain assets with stablecoins, eliminating the cumbersome procedures and extra costs associated with cross-chain bridging, making it particularly suitable for efficient trading of popular multi-chain tokens.

The core competitiveness of this protocol comes from its groundbreaking design of underlying infrastructure. By utilizing zero-knowledge proofs and an aggregated Rollup architecture, it addresses the issues of liquidity fragmentation, high transaction costs, and cross-chain complexity faced by traditional DEXs. Its multi-chain liquidity aggregation capability unifies assets scattered across multiple networks, forming a deep liquidity pool, allowing users to obtain the best trading prices without the need for cross-chain transactions. At the same time, zk-Rollup technology enables off-chain batch processing of transactions, coupled with recursive proofs to optimize verification efficiency, resulting in throughput that approaches that of centralized exchanges, with transaction costs being only a small fraction of similar platforms. Compared to single-chain optimized DEXs, this protocol offers users a more flexible and low-threshold trading experience through cross-chain interoperability and unified asset listing mechanisms.

A certain exchange: The revolution of privacy and efficiency based on ZK Rollup

The exchange employs zero-knowledge technology, combining the privacy attributes of Zk-SNARKs with the depth of order book liquidity. Users can anonymously verify the validity of transactions (such as margin sufficiency) without exposing position details to prevent MEV attacks and information leakage, successfully solving the industry's dilemma of "transparency versus privacy." By utilizing a Merkle Tree, hundreds of transaction hashes are aggregated into a single root hash on-chain, greatly compressing on-chain storage costs and gas consumption. Through the coupling of Merkle Tree with on-chain verification, it provides retail investors with a "no-compromise solution" that offers centralized exchange-level experience and decentralized exchange-level security.

In the design of the LP pool, the exchange adopts a hybrid LP model, seamlessly connecting users' stablecoin and LP Token exchange operations through smart contracts, while also taking into account the advantages of on-chain transparency and off-chain efficiency. When users attempt to exit the liquidity pool, a delay is introduced to prevent market liquidity supply instability caused by frequent entry and exit. This mechanism can reduce price slippage risk, enhance the stability of the liquidity pool, and protect the interests of long-term liquidity providers, preventing market manipulators and opportunistic traders from profiting from market fluctuations.

In traditional centralized exchanges, large capital clients need to rely on the liquidity of all users on the order book to exit liquidity, which can easily lead to a market crash. However, the hedging market-making mechanism of this exchange can effectively balance the supply of liquidity, ensuring that institutional investors' exits do not overly depend on retail funds, allowing retail investors to avoid bearing excessive risks. It is more suitable for professional traders who prefer high leverage, low slippage, and are averse to market manipulation.

Future Direction: The Possibility of Liquidity Democratization

The future DEX liquidity design may develop along two different branches: Global Liquidity Network: Cross-chain interoperability technology breaks down silos, maximizing capital efficiency, allowing retail investors to achieve the optimal trading experience through "seamless cross-chain"; Co-governance Ecology: Through innovative mechanism design, DAO governance shifts from "capital dominance" to "contribution rights", forming a dynamic balance between retail investors and institutions in the game.

Cross-Chain Liquidity Aggregation: From Fragmentation to Global Liquidity Network

This path builds the underlying infrastructure using cross-chain communication protocols, achieving real-time data synchronization and asset transfer between multiple chains, eliminating reliance on centralized bridging. By using zero-knowledge proofs or light node verification technology, it ensures the security and immediacy of cross-chain transactions.

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