By Sergey Vartanov Khachaturyan and Nelson Ryan
In November 2022, crypto exchange FTX filed for Chapter 11 bankruptcy protections as it attempted to assess the value of its remaining assets collapsed. The failed exchange was soon found to have an over $7b shortfall in assets due to bad loans made to sister market-making firm Alameda Research with customer deposits.
In the wake of 2022's tumultuous events, epitomised by the downfall of FTX, the crypto community faced a stark reminder of the inherent risks in centralised exchanges. FTX's collapse was not just a one-off scandal but the continuation of a troubling trend of centralised exchange collapses. This incident underscored a fundamental flaw in the opaque nature of centralised exchanges: the over-reliance on trust-based custodial systems. Trust which in this case ultimately ended in fraud and mismanagement.
The ethos of crypto has always been rooted in decentralization and the elimination of trust-based systems. DEXs embody this principle by enabling permissionless peer-to-peer transactions without intermediaries, mitigating the risks associated with asset exchange. The trustless exchange of one crypto asset for another enables a new way of trading assets, enabling a new way to bootstrap liquidity for a market. The growth in DEX usage reflects a broader industry shift as users seek more control over their assets and a reduction in counterparty risk.
Over the past 4 years, we have seen DEXs rise from a large niche hobbyist market to one of the primary ways transactions are settled in the crypto space. The rise of Automated Market Maker [AMM] DEXs led primarily by Uniswap radically simplified the DEX experience making it easy for anyone to perform a swap in a few clicks. In 2023 the portion of DEX volume relative to CEX volume crossed over 20% reaching an all-time high driven by on-chain trading of meme coins on Ethereum.
DEXs have grown considerably in recent years, and the market is considerably larger when looking at broader centralised exchange volumes. The opportunity for DEXs remains to eat into the CEX market which at its peak in May 2021 rose above $4 trillion in volume and over $1.1 trillion in December 2023. While CEXs historically have had an advantage over DEXs due to superior liquidity and a smoother user experience, DEXs today have an opportunity to dramatically simplify this experience, swapping one asset for another wallet to wallet. For the space to reach its full potential there is a need for permissionless swaps.
DEX volume today remains largely exchanging assets that exist on the same chain, however, the dream for DEXs has always been true cross-chain swaps allowing direct exchange of one asset for another between different blockchains. While bridges offer one solution to this problem, they do come with their own trust assumptions and security risks, which may not always be clear to the end user. Seamless cross-chain swaps of one asset for another remain the gold standard for lowering the barriers between blockchains. Crypto is rapidly evolving towards a multichain future, necessitating platforms that enable seamless cross-chain interactions.
Chainflip is a decentralized protocol designed to address the challenges of cross-chain swaps in crypto. It stands out by enabling seamless and secure exchanges of assets between diverse blockchains, directly from users' wallets, bypassing the need to rely on centralised exchanges or bridging solutions. Chainflip leverages a dual-layer structure comprising an Accounting Layer and a Settlement Layer. The Accounting Layer, operating on a proof-of-stake consensus, maintains the protocol's state, including tracking deposits, withdrawals, and swaps.
Chainflip System Overview
Chainflip simplifies the user experience of cross-chain swaps by eliminating the complexities associated with wrapped tokens and specialised wallets. The protocol achieves this through a robust network of validators and the use of Threshold Signature Schemes, minimising reliance on centralised entities and single points of failure.
Unlike some existing IBC-reliant approaches, Chainflip offers true interoperability between different blockchains without requiring any modifications to the existing chain infrastructure. Chainflip achieves this by facilitating swaps directly from wallet to wallet without using wrapped tokens or specific blockchain integrations, which can limit their scope and increase complexity. This approach also dramatically improves Chainflip's user experience with users performing swaps directly from their wallets, without transferring assets to a centralised exchange or navigating complex bridging protocols.