Introduction: The underlying logic of liquidity game
In the financial market, retail investors are often seen as the "buyers" of institutional investors when they exit liquidity - when institutions need to sell off on a large scale, retail investors often passively take over assets with falling prices. This asymmetry is further amplified in the field of cryptocurrency, and the market maker mechanism and dark pool trading of centralized exchanges (CEX) have exacerbated this information gap. However, with the evolution of decentralized exchanges (DEX), new order book DEXs represented by dYdX and Antarctic are reconstructing the distribution of liquidity power through mechanism innovation. This article will take technical architecture, incentive mechanism and governance model as the entry point to analyze how excellent DEXs can achieve physical isolation between retail and institutional liquidity.
Liquidity stratification: from passive assumption to power reconstruction
The liquidity dilemma of traditional DEX
In the early AMM (automated market maker) model, retail investors' liquidity provision (LP) behavior has significant adverse selection risks. Taking Uniswap V3 as an example, although its centralized liquidity design improves capital efficiency, data shows that the average position of retail LP is only US$29,000, and is mainly distributed in small pools with daily trading volume below US$100,000; while professional institutions dominate large trading pools with an average position of US$3.7 million, and institutions account for as much as 70-80% of the pools with daily trading volume exceeding US$10 million. Under this structure, when institutions execute large-scale sell-offs, retail investors' liquidity pools bear the brunt and become a buffer for price declines, forming a typical "exit liquidity trap."
The necessity of liquidity stratification
Research by the Bank for International Settlements (BIS) revealed that the DEX market has shown significant professional stratification: although retail investors account for 93% of the total number of liquidity providers, 65-85% of actual liquidity is provided by a small number of institutions. This stratification is not accidental, but an inevitable result of market efficiency optimization. Excellent DEXs need to separate and manage the "long-tail liquidity" of retail investors from the "core liquidity" of institutions through mechanism design. For example, the MegaVault mechanism launched by dYdX Unlimited allocates the USDC deposited by retail investors to the sub-fund pools dominated by institutions through algorithms, which not only ensures the depth of liquidity, but also prevents retail investors from being directly exposed to the impact of large transactions.
Technical Mechanism: Building a Liquidity Firewall
Innovation of the order book model
DEXs that use order books can build a multi-level liquidity protection mechanism through technological innovation. The core goal is to physically isolate the liquidity needs of retail investors from the large-scale transactions of institutions, so as to prevent retail investors from passively becoming "victims" of drastic market fluctuations. The design of a liquidity firewall needs to take into account efficiency, transparency and risk isolation capabilities. The core is to use a hybrid architecture that combines on-chain and off-chain collaboration to protect user asset autonomy while resisting the impact of market fluctuations and malicious operations on the liquidity pool.
The hybrid model places high-frequency operations such as order matching off-chain, and uses the low latency and high throughput characteristics of off-chain servers to significantly increase transaction execution speed and avoid slippage caused by blockchain network congestion. At the same time, on-chain settlement ensures the security and transparency of asset self-custody. For example, DEXs such as dYdX v3, Aevo, and Antarctic match transactions through off-chain order books and complete final settlement on-chain, which not only retains the core advantage of decentralization, but also achieves transaction efficiency close to that of CEX.
At the same time, the privacy of the off-chain order book reduces the pre-exposure of transaction information, effectively suppressing MEV behaviors such as front-running and sandwich attacks. For example, projects such as Paradex reduce the market manipulation risks brought by on-chain transparent order books through hybrid models. The hybrid model allows access to the professional algorithms of traditional market makers, and provides tighter bid-ask spreads and depth through the flexible management of off-chain liquidity pools. Perpetual Protocol adopts a virtual automated market maker (vAMM) model, combined with an off-chain liquidity supplement mechanism, to alleviate the high slippage problem of pure on-chain AMMs.
Processing complex calculations off-chain (such as dynamic funding rate adjustments and high-frequency trading matching) reduces on-chain gas consumption, while only key settlement steps need to be processed on-chain. Uniswap V4's singleton contract architecture merges multi-pool operations into a single contract, further reducing gas costs by 99%, providing a technical foundation for the scalability of the hybrid model. The hybrid model supports deep integration with DeFi components such as oracles and lending protocols. GMX obtains off-chain price data through the Chainlink oracle, combined with the on-chain clearing mechanism, to achieve the complex functions of 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 and prevent systemic risks caused by malicious operations and market fluctuations. The general practice is to introduce a time lock (such as a 24-hour delay, up to 7 days) when LP exits to prevent the instantaneous depletion of liquidity caused by high-frequency withdrawals. When the market fluctuates violently, the time lock can buffer panic withdrawals and protect the returns of long-term LPs. At the same time, the lock-up period is transparently recorded through smart contracts to ensure fairness.
Based on the oracle's real-time monitoring of the asset ratio of the liquidity pool, the exchange can also set dynamic thresholds to trigger the risk control mechanism. When the proportion of a certain asset in the pool exceeds the preset upper limit, the relevant transaction is suspended or the rebalancing algorithm is automatically called to avoid the expansion of impermanent loss. Tiered rewards can also be designed according to the LP's lock-up period and contribution. LPs who lock assets for a long time can enjoy higher handling fee sharing or governance token incentives, thereby encouraging stability. The Hooks function of Uniswap V4 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 the on-chain circuit breaker mechanism. Suspend transactions of specific trading pairs or limit large orders, similar to the "circuit breaker" mechanism of traditional finance. Ensure the security of liquidity pool contracts through formal verification and third-party audits, and use modular design to support emergency upgrades. Introduce a proxy contract model to allow vulnerabilities to be fixed without migrating liquidity, avoiding a recurrence of events like The DAO.
Case Studies
dYdX v4 — Fully decentralized implementation of the order book model
dYdX v4 maintains the order book off-chain, forming a hybrid architecture of off-chain order book and on-chain settlement. A decentralized network consisting of 60 verification nodes matches transactions in real time, and only completes the final settlement through the application chain built by Cosmos SDK after the transaction is completed. This design isolates the impact of high-frequency trading on retail liquidity off-chain, and only processes the results on the chain to avoid retail LPs being directly exposed to price fluctuations caused by large order withdrawals. The gas-free trading mode only charges a proportional handling fee after the transaction is successful, avoiding retail investors from bearing high gas costs due to high-frequency order withdrawals and reducing the risk of passively becoming "exit liquidity".
When retail investors stake DYDX tokens, they can obtain USDC stablecoin income of 15% APR (from transaction fee sharing), while institutions need to stake tokens to become verification nodes, participate in off-chain order book maintenance and obtain higher returns. This layered design separates retail investors' income from institutional node functions to reduce conflicts of interest. Unlicensed listing is isolated from liquidity, and the USDC provided by retail investors is allocated to different sub-pools through algorithms to prevent a single asset pool from being penetrated by large transactions. Token holders decide on the fee allocation ratio, new trading pairs and other parameters through on-chain voting, and institutions cannot unilaterally modify the rules to harm the interests of retail investors.
Ethena — Stablecoin Liquidity Moat
When users pledge ETH to generate the Delta-neutral stablecoin USDe, the Ethena protocol automatically opens an equal amount of ETH perpetual contract short positions on CEX to achieve hedging. Retail investors holding USDe only bear the spread between ETH pledge income and funding rates, avoiding direct exposure to spot price fluctuations. When the USDe price deviates from $1, arbitrageurs need to redeem collateral through on-chain contracts, triggering a dynamic adjustment mechanism to prevent institutions from manipulating prices through concentrated selling.
Retail investors pledge USDe to obtain sUSDe (income tokens), and the income comes from ETH staking rewards and funding rates; institutions obtain additional incentives by providing on-chain liquidity through market making, and the income sources of the two roles are physically isolated. Injecting reward tokens into the USDe pool of DEXs such as Curve ensures that retail investors can exchange with low slippage and avoid being forced to take on institutional selling pressure due to insufficient liquidity. In the future, it is planned to control the type of USDe collateral and hedging ratio through the governance token ETA, and the community can vote to limit excessive leverage operations of institutions.
ApeX Protocol — Flexible Market Making and Protocol Control Value
ApeX Protocol migrated from StarkEx to zkLink X to build an efficient order book contract trading model with off-chain matching and on-chain settlement. User assets adopt a self-custody mechanism, and all assets are stored in on-chain smart contracts to ensure that the platform cannot misappropriate funds. Even if the platform stops operating, users can still force withdrawals to ensure safety. ApeX Omni contracts support seamless deposits and withdrawals of multi-chain assets, and adopt a design that does not require KYC. Users only need to connect to their wallets or social accounts to trade, while exempting Gas fees to significantly reduce transaction costs. In addition, ApeX spot trading innovatively supports USDT's one-click buying and selling of multi-chain assets, eliminating the cumbersome process and additional costs of cross-chain bridging, and is especially suitable for efficient transactions of multi-chain Meme coins.
ApeX's core competitiveness stems from the breakthrough design of its underlying infrastructure, zkLink X. zkLink X solves the problems of liquidity fragmentation, high transaction costs and cross-chain complexity faced by traditional DEXs through zero-knowledge proof (ZKP) and aggregated Rollup architecture. Its multi-chain liquidity aggregation capability will unify assets scattered across L1/L2 networks such as Ethereum and Arbitrum to form a deep liquidity pool, where users can get the best transaction price without crossing chains. At the same time, zk-Rollup technology realizes off-chain batch processing of transactions, and combined with recursive proof to optimize verification efficiency, ApeX Omni's throughput is close to the CEX level, and the transaction cost is only a tiny fraction of that of similar platforms. Compared with single-chain optimized DEXs such as Hyperliquid, ApeX provides users with a more flexible and low-threshold trading experience with cross-chain interoperability and a unified asset listing mechanism.
Antarctic Exchange — A privacy and efficiency revolution based on ZK Rollup
Antarctic Exchange uses Zero Knowledge technology to deeply combine the privacy properties of Zk-SNARKs with order book liquidity. Users can anonymously verify the validity of transactions (such as margin adequacy) without exposing position details to prevent MEV attacks and information leakage, successfully solving the industry problem of "transparency and privacy cannot be achieved at the same time". Through Merkle Tree, thousands of transaction hashes are aggregated into a single root hash on the chain, which greatly compresses the on-chain storage cost and on-chain Gas consumption. Through the coupling of Merkle Tree and on-chain verification, a "no-compromise solution" is provided for retail investors with CEX-level experience and DEX-level security.
In the design of the LP pool, Antarctic adopts a hybrid LP model, which seamlessly connects the exchange operations of user stablecoins and LP Tokens (AMLP/AHLP) through smart contracts, and also takes into account the advantages of on-chain transparency and off-chain efficiency. A delay is introduced when a user tries to exit the liquidity pool to prevent the instability of market liquidity supply caused by frequent entry and exit. This mechanism can reduce the risk of price slippage, enhance the stability of the liquidity pool, and protect the interests of long-term liquidity providers, preventing market manipulators and opportunistic traders from taking advantage of market fluctuations to make profits.
In traditional CEX, if large capital customers want to withdraw liquidity, they need to rely on the liquidity of all users of the order book, which can easily cause stampedes and market crashes. However, Antarctic's hedging market-making mechanism can effectively balance the supply of liquidity, so that the withdrawal of institutional investors will not be overly dependent on the funds of retail investors, so that retail investors do not need to bear excessive risks. It is more suitable for professional traders with high leverage, low slippage and aversion to market manipulation.
Future Directions: The Possibility of Democratizing Liquidity
The future DEX liquidity design may have two different development branches: global liquidity network : cross-chain interoperability technology breaks the island and maximizes capital efficiency. Retail investors can get the best trading experience through "seamless cross-chain"; co-governance ecology : through mechanism design innovation, DAO governance shifts from "capital power" to "contribution confirmation", and retail investors and institutions form a dynamic balance in the game.
Cross-chain liquidity aggregation: from fragmentation to global liquidity network
This path uses cross-chain communication protocols (such as IBC, LayerZero, and Wormhole) to build the underlying infrastructure, achieve real-time data synchronization and asset transfer between multiple chains, and eliminate the reliance on centralized bridges. Through zero-knowledge proof (ZKP) or light node verification technology, the security and immediacy of cross-chain transactions are ensured.
Combining AI prediction models with on-chain data analysis, smart routing will automatically select the liquidity pool of the best chain. For example, when the Ethereum mainnet ETH sell-off causes slippage to increase, the system can instantly dismantle liquidity from Polygon or Solana's low-slippage pools, and complete cross-chain hedging through atomic swaps, reducing the impact cost of retail pools.
Or a unified liquidity layer can be designed to develop a cross-chain liquidity aggregation protocol (such as the Thorchain model), allowing users to access multi-chain liquidity pools at a single point. The capital pool adopts the "Liquidity as a Service" (LaaS) model, allocated to different chains on demand, and automatically balances the price difference between chains through arbitrage robots to maximize capital efficiency. A cross-chain insurance pool and a dynamic rate model are introduced to adjust premiums based on the frequency of liquidity use and security level of different chains.
Game balance in DAO governance: from whale monopoly to multiple checks and balances
Different from the previous route, DAO governance dynamically adjusts voting weights. The voting weight of governance tokens increases with holding time (such as the veToken model). DAO encourages organization members to participate in community governance for a long time and inhibits short-term manipulation. The weights are dynamically adjusted in combination with on-chain behaviors (such as liquidity provision duration and transaction volume) to avoid power concentration caused by large-scale hoarding of coins.
Combined with the existing dual-track system, core decisions involving liquidity allocation must meet both "more than half of the total votes" and "more than half of the retail addresses" to prevent unilateral control by whales. Retail investors can delegate their voting rights to "governance nodes" that have passed reputation certification. Nodes must pledge tokens and undergo transparent audits. Abuse of power will result in the confiscation of the pledged deposit. Additional benefits will be given to liquidity providers (LPs) participating in governance, but if voting behavior deviates from community consensus, the benefits will be reduced proportionally.
As a medium for the transfer and transaction of labor relations, NFT can play an important role in the governance of DAO. For example, the rebate relationship that all exchanges have can be directly bound to NFT. When NFT is traded, the rebate relationship and the corresponding customer resources will be transferred together, and the value of this NFT can also be directly quantified by the number of resources. At present, DEX has made corresponding attempts to allow NFT to flow quickly to users who are really willing to promote DEX through transactions on opensea. More than 90% of the performance of the entire operating department comes from NFT rebates. The anonymity of NFT can also help DAO better manage the BD department and will not cause user loss due to the departure of a certain BD.
Conclusion: A paradigm shift in liquidity power
Excellent DEX essentially reconstructs the distribution of financial power through technical architecture. The practices of dYdX, Antarctic and others have shown that when the liquidity provision mechanism shifts from "passive acceptance" to "active management", and when transaction matching is upgraded from "price priority" to "risk isolation", retail investors will no longer be victims of institutional withdrawal, but equal participants in the co-construction of the ecosystem. This change is not only about technical efficiency, but also the core embodiment of the DeFi spirit - returning finance to its service essence rather than a battlefield of zero-sum games.
