The Rise of On-Chain Order Book DEXs

On-chain transactions have emerged since the dawn of Bitcoin, though Bitcoin’s rudimentary infrastructure limited them. These early transactions were merely peer-to-peer transfers, while Bitcoin trading heavily dependent on centralized exchanges.

With the advent of Ethereum, the introduction of smart contracts made on-chain trading a reality. Early on-chain trading methods, like BitShares, followed the order book model, much like traditional stock markets and forex trading. Interestingly, Automated Market Maker (AMM) DEXs, which came later, now dominate over 90% of the market.

The reason lies in the high-performance, low-fee engines and professional market makers required for order book mechanisms. Additionally, AMMs are naturally suited for generating initial liquidity for low-liquidity tokens, such as meme coins. The longstanding dominance of centralized exchanges (CEXs) like Binance has also led to a preference for off-chain trading of large assets.

However, products like Phoenix on Solana are emerging, bringing a trading experience that closely mirrors traditional CEXs. This development signals a potential resurgence for order book mechanisms.

Order Book: A Point-to-Pool Trading System

In essence, the difference between order book and AMM mechanisms is that in order book trading, users are effectively trading with professional market makers. On the other hand, although AMM DEXs also have liquidity providers (LPs), they function as swaps between two asset pairs, coordinated by smart contracts.

More precisely, order book DEXs operate similarly to traditional centralized exchanges. Users can submit buy and sell orders, which are recorded on the blockchain and automatically executed by smart contracts. The main feature of order book DEXs is the use of an order book to match buy and sell orders, ensuring fairness and efficiency through algorithms like FIFO (First-In-First-Out).

After Ethereum’s launch, EtherDelta and dYdX developed spot and derivatives order book products, respectively. Particularly dYdX, which, alongside Uniswap, has long dominated on-chain derivatives and spot trading, maintaining a significant market share for order book mechanisms.

dYdX is not just an order book-based DEX; it supports complex trading strategies, including various order types like limit, market, FAK, and FOK. It also integrates liquidity mining mechanisms and has developed the dYdX Chain, making it the leading on-chain derivatives DEX.

The early drawbacks of order book mechanisms were primarily due to a lack of on-chain liquidity and transaction efficiency issues. Following the 2021 DeFi Summer, a series of high-performance blockchains like Solana, Aptos, and Sui targeted order book DEXs, hoping to create new ecosystems beyond the “Ethereum + Uniswap” dominance, introducing innovative ideas.

One of these innovations is the off-chain computation mechanism, where trades are matched off-chain and confirmed on-chain. While this approach introduces centralization concerns, it helps prevent MEV (Maximal Extractable Value) issues and improves transaction success rates, making it the mainstream choice.

Hybrid Trading: Bridging Order Books and AMMs. Order books and AMMs are not mutually exclusive. While AMMs provide instant liquidity, they often suffer from slippage issues. Order book mechanisms can mitigate these problems, leading to an increasing number of hybrid DEXs.

Multi-Chain Parallelism: The Ethereum ecosystem remains the primary reservoir of on-chain capital, while high-performance blockchains like Solana and Sui excel in meeting the demands of order book matching efficiency. Thus, using Solana for matching and Ethereum for confirmation represents a potential development path.

Looking at the history and characteristics of order book DEXs, after AMM mechanisms and Uniswap secured the majority of the market share. The increasing on-chain liquidity and the rise of high-performance blockchains and Layer 2 solutions have set the stage for an explosive growth period for order book DEXs.

Examining the Details: dYdX V4 and Bluefin

Similar to the various branches of AMM mechanisms, order book mechanisms have also evolved into different applications.

Bluefin is a DEX based on the Central Limit Order Book (CLOB) mechanism, operating on the Sui blockchain, and primarily offering derivatives trading services.

The Central Limit Order Book (CLOB) is a trading model commonly used in centralized exchanges. Its core function is to match traders’ buy and sell orders through a transparent system, prioritizing them by price and time for execution.

Moreover, CLOBs can ensure anonymity by concealing the specific prices and quantities of orders. For instance, Hidden Limit Orders and Mid-Price Pegged Orders must meet a minimum execution quantity, akin to the traditional concept of dark pools.

Specifically, Bluefin maintains a decentralized off-chain order book on Sui, using a multi-node network to maintain and update the Sui DEX order book. Bluefin’s governance system selects nodes to ensure minimized trust.

Bluefin has performed exceptionally well within the Sui ecosystem, achieving a 24-hour trading volume of $400 million, making it the third-largest DeFi derivatives protocol and the top derivatives protocol in the Sui ecosystem by trading volume.

In the more well-known dYdX V4 version, similar to Bluefin, it also opted to detach from Ethereum, building its own dYdX Chain to meet the customized needs of on-chain trading.

From a broader perspective, dYdX V4 operates with its front-end run by the dYdX Operations SubDAO, while the order book and matching engine are managed by globally active validators. Users trade on the front end, with orders routed to validators who transfer the transactions to other validators and full nodes to update the order book.

As a blockchain, dYdX V4 is primarily based on the Cosmos SDK and CometBFT POS (Proof of Stake) mechanism, developed as an independent blockchain within the Cosmos ecosystem. dYdX V4 aims to migrate from Ethereum to a dedicated dYdX application chain, planning to establish a fully decentralized order book and matching engine to ensure all trading activities occur in a decentralized environment, completely avoiding centralized components.

The migration of dYdX V4 will also address throughput and scalability issues, enhancing decentralization and sovereignty. By migrating to the dYdX Chain, dYdX aims to significantly improve its transaction speed, allowing the platform to handle more trades and orders. dYdX V4’s creation of an independent blockchain will further strengthen its decentralized characteristics. Specifically, the migration of dYdX V4 to the Cosmos network will enable the complete decentralization of the off-chain order book and matching engine, increasing throughput with a scalability higher than any current blockchain.

Conclusion

In the nearly decade-long evolution of order book mechanisms, they have followed a unique path- first emerging in derivatives before moving to spot trading. The core reason is the inability to fully replicate existing market routes, which is only possible once the on-chain infrastructure and user base reach a certain scale.