A Case for DEX on Bitcoin

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This post originally appeared on the ZeMing M. Gao’s website, and we republished with permission from the author. Read the full piece here.

Although not a firm believer of decentralized finance (DeFi) and decentralized exchange (DEX) in their present forms in a general sense, I find it worthwhile to share the following truth:

Superior DEX can be built on Bitcoin blockchain.

For most people, it is a big surprise to hear that a decentralized exchange (DEX) can be, and already has been, built on Bitcoin blockchain; and it meets with incredulity and ridicule when you say that DEX built on Bitcoin blockchain is superior to any other DEXs.

Most people today are still living with ignorant falsehood such as “Bitcoin is not Turing complete,” or “Bitcoin does not support smart contracts.”

But Bitcoin was Turing complete from the very beginning, and Bitcoin has always had smart contract capabilities. And Bitcoin can do not just DEX, but in fact superior DEX.

DeFi & DEX

As part of the DeFi (decentralized finance) movement, decentralized exchanges (DEX) have had explosive developments in the recent years, and taken the digital currency market by storm. Uniswap, for example, rose to a market cap of $15 billion from nothing in just two short years.

The premise of DEX is to facilitate peer-to-peer trading without the support of a centralized intermediary in its ordinary sense. While centralized exchanges such as Binance have been also working on a type of DEXs which are order-book-based, a new type of DEXs that employ liquidity pool protocols to effectuate AMM (automated market maker) and to allow swaps have attracted more attention. Uniswap, PancakeSwap, and SushiSwap are this type of DEXs, and have all achieved multibillion-dollar valuations on the digital currency market.

Most of the swap DEXs grew from and have been built on the Ethereum blockchain. It is a result of a historical misunderstanding of Bitcoin blockchain. The misunderstanding is a result of a persistent propaganda based on intentionally misleading disinformation. And the same misunderstanding led to the creation of Ethereum in the first place, when everything Ethereum purported to do could have been done on Bitcoin, only better.

At least in a technical sense, the true Bitcoin blockchain according to Satoshi Nakamoto’s original design (Bitcoin Satoshi Vision, or BSV) supports fundamentally better DeFi or DEX. This is because of, not in spite of, the characteristics of Bitcoin blockchain.

This is already happening with TokenSwap.

TokenSwap

TokenSwap is a liquidity pool type swap exchange based on the BSV blockchain. All transactions are on-chain, layer-1 (L1), enabled by smart contracts coded using sCrypt, an advanced programming language built on top of Bitcoin scripts. The platform started in September 2021.

On its website, TokenSwap lists numerous advantages, including:

• Funds kept in non-custodial wallet
• Onchain trading
• 0 confirmation on deposit/instant deposit
• Instant withdrawal
• 0 withdrawal fee
• Unlimited TPS (compared with ETH)
• Free from exchange hacks because of account information leakage
• Free of unplug, manipulation from exchanges that fake or delete user data for their own favor
• No front-running, which happens on ETH DEXs that causes loss to users
• Instant matching between users or user-pool with low fees, instant settlement

TokenSwap on TokenSwap — AMM DEX running on BSV (tswap.io)

Most if not all of the advantages described by TokenSwap are real. TokenSwap is BSV-based on-chain swaps. Its advantages over central exchanges (CEX) are obvious. But when compared with other decentralized exchanges (DEX), especially AMM swaps (like Uniswap), it is less obvious.

Key advantages of TokenSwap over other Layer-1 (L1) swaps:

1. Better economics

Due to the much lower on-chain transaction fees on BSV blockchain, it is much less costly to do small amount transactions on TokenSwap, and this tends to translate to higher trading volumes, which in turn has potential to lead to more sophisticated trading systems.

There are two different kinds of fee involved in making a trading transaction. One is the trading commission, which is usually a fixed percentage and comparable among all the DEX exchanges, including TokenSwap. The other is an on-chain transaction fee, or sometimes called “network fee”, charged by the underlying blockchain (more specifically by miners).

The trading commission (fee) is charged by the trading platform and is usually in the range of 0.2% to 0.3%, with little differentiation among different DEX platforms.

The network fee, however, is vastly different on BSV and other chains.

Even with large complex Sensible Contracts coded in sCrypt not optimized to reduce the script size, the fee per transaction on BSV chain is under $0.10 (and the fee is trending further lower both because of the contract script size optimization and BSV’s constantly diminishing network fees per byte). Compared to most other chains such as Ethereum which typically costs more than $10 per transaction, this part is almost negligible on BSV.

If you’re making a fairly large transaction, say $1000, $10,000 or above, the difference is minimal percentage-wise, as most people probably wouldn’t mind or even notice a $10 fee for $10,000 transaction which is 0.1%. But if you’re making transactions less than $100, the difference is quite large. A $10 fee for a $100 trade is 10%.

This difference in fees means that TokenSwap users are more likely to make frequent small amount transactions on its trading platform. This, in turn, means that the level of transaction volumes per unit locked asset value on TokenSwap is likely to be able to achieve a much higher level than that of high-fee L1 swaps.

The potential impact of significantly lower transaction fees may go far beyond mere user cost savings and higher transaction volumes. History tells us that lower transaction fees is the most fundamental mechanism or catalyst for deep changes in business models. Advanced automation, even AI assisted processes, would be enabled with low transaction fees but would not be possible with high transaction fees. Low transaction fee opens up new doors and even creates new fields of development.

2. Frontrunning prevention

Another important advantage of BSV-based TokenSwap over other L1 swaps is that it has a mechanism to prevent frontrunning.

Frontrunning is an extremely detrimental loophole on almost all DEXs. It happens when someone observes another person’s pending order and takes advantage of the order by submitting a frontrunning order which is executed before the other pending order by making a higher fee bidding for faster processing. It is also rather unique to DEXs, because, at least in theory, CEXs can hide the orders from the public, but DEXs cannot, as transparent on-chain information is characteristic of any public blockchain.

On CEXs facilitated by an intermediary, frontrunning is illegal because usually it is the party that has fiduciary duty that sees another party’s orders. It is suspected that on digital currency CEXs, illegal frontrunning does happen anyway (if it even happens on stock brokerages which are strictly regulated, it does not require a stretch of imagination for this to happen more easily on digital currency CEXs that have thrived due to a lack of regulation and compliance), but at least people know it is illegal and therefore suppose it does not happen regularly.

On DEX, however, because the order information is public, frontrunning is not only possible, but could even be legal.

But TokenSwap is different, because BSV is different:

BSV blockchain processes transactions on the first-seen basis, and the order of processing cannot be changed by fee bidding, thus preventing frontrunning. With BSV, miners still require the transaction fees to meet their minimum (or the transactions may be ignored), but as long as the transactions meet miners fee requirement, they get in sequentially.

You might ask why couldn’t other chains implement the same policy. Well, it really is not up to them when their chain has frequent congestion problems. Fee bidding is a necessary mitigation measure for alleviating the congestion problem for chains such as Ethereum. It’s the reality, and one cannot have it both ways. To put it shortly, when you have an inadequate chain, you may hide it somewhat by playing tricks, but you can’t make the deficiency disappear by magic. It always comes back one way or another.

At the same time, BSV enables instant matching between users or user-pool with instant settlement, leaving no room for frontrunning. Again, this is not possible with a blockchain such as Ethereum.

Advantages of TokenSwap over Layer-2 (L2) swaps:

Layer-2 (L2) DEX is different, in that a DEX based on a L2 solution will be able to reduce the fees significantly.

However, the problems of L2 solutions are fundamental: it is not blockchain. They just pretend to be blockchain. Having started with a blockchain that has failed to provide a real solution, it creates an off-chain solution but associates itself with blockchain in name, in order to ride on the market tide created by the blockchain hype.

This is not to say that L2 is completely useless in principle. But the truth is that, other than high-frequency data or content streaming applications, one can hardly think of any L2 applications that are necessary when a public blockchain that can provide truly scalable Layer-1 (L1) solutions already exists.

L2 is always a compromise. People who don’t see this should ask themselves a very simple question: why inventing blockchain in the first place at all? If L2 could be a good solution, the existing non-blockchain technologies such as distributed databases would have all the answers that are not only just as good but in fact also enjoy a far more mature and established ecosystem, so there would be absolutely no need for blockchain.

To put it simply, any transaction that needs to be, or should be, atomic, or potentially needs to be distinctively identified (for accounting or auditing purposes for example), should be on chain, otherwise there would be no need of blockchain technology in the first place. Placing these types of transactions on L2 is dishonesty.

And trading transactions are certainly this type of transactions.

High-frequency data or content streaming applications are the only exceptions that would justify L2 solutions such as payment channels.

(Note, I’m talking about transactions not tokens themselves here, as they are different things. There can be a strong case made for L2 tokens for many commercial applications, and that is what Tokenized.com is doing, but that’s a whole different subject.)

But BSV? Bitcoin?

Wait, the title says “Bitcoin,” but you talk about BSV?

Well, in short, BSV (Bitcoin Satoshi Vision) is the only blockchain that is truthful to the original bitcoin design by the Bitcoin inventor Satoshi Nakamoto, and Satoshi himself is completely behind BSV. Other chains such as BTC, BCH are not the true bitcoin.

Bitcoin Satoshi Vision (BSV) is the only blockchain that has the following properties:

• Unbounded scalability (orders of magnitude more scalable, designed to reach TPS in the millions);
• Supremely secure and reliable (the only blockchain that has the maximal PoW security track record);
• Extremely low cost (orders of magnitude less expensive, at 1/100th of a cent per transaction);
• Instantly verifiable transactions (due to UTXO, SPV and verification-before-the-next-chain);
• Full smart contract capacity with Turing completeness.

For more information, please read the following articles on BSV (as serious tech/economics studies):

• BTC and BSV, what is the real difference?
• Why BSV is a value creating system, while BTC a value absorbing system?
• Proof of Work (PoW) is the only way to prevent corruption
• Why I Believe Craig Wright is Most Likely Satoshi
• In expectation of the historic Bitcoin trial: Kleiman v. Wright

Prospects

DEX on Bitcoin blockchain is just starting. TokenSwap is only two months old and still very small. It could fail (this not being a prediction, but just a hypothetical). But if TokenSwap fails to make it, somebody else will eventually do on the BSV blockchain, because the technological advantages are enormous.

TokenSwap uses a base trading token TSC to facilitate all trading. Trading fees are paid in TSC. TSC tokens are released primarily in the form of farming payouts to incentivize early adopters. Liquidity providers who don’t want to do farming do not receive farming payouts, but earn transaction fees.

The TokenSwap platform now has roughly about $10 million of total assets locked in the pools for trading. Its base trading token TSC has a current valuation (market cap) of around $4 million based on the number of TSC tokens already released and the current TSC token price, and its fully diluted valuation is about $60 million (when all one billion TSC tokens are released in about 28 months from now), based on the current TSC token price.

Because TokenSwap charges 0.25% fees for all trading pairs, of which 0.04%(16% of the total fee) will be used to repurchase TSC, and repurchased TSC will be burnt, the total number of existing TSC tokens will be less than one billion, making the TSC valuation more favorable. The actual percentage of TSC that will be burnt depends on the trading volume. The higher the trading volume, the more TSC will be burnt. Therefore, the trading volume has a double-positive impact on TSC tokenomics.

Given the total value of assets locked in the pools for trading, if you assume the level of trading activities per unit total asset value is comparable to the general digital currency market (see below), a rough estimate of the annual trading revenue generated from charging transaction fees on TokenSwap would be close to $400K, which means a bit over $1000 daily transaction fee. (Note: $1000 daily transaction fee is just a conservative estimate, and the actual number is likely higher. TokenSwap team would have a much better view on the actual transaction volume and resultant fees, and hope they can release such numbers.)

Considering that the transaction fee is almost pure profit for TSC token holders, it easily justifies a current market cap of TSC to be at least $8 million, assuming a modest P/E ratio of 20. And this does not even include the farming payouts, which is far more than the regular transaction fees earned by the liquidity providers in the early stages.

However, the above uses a traditional fundamental valuation metrics (P/E ratio) to price TSC token. It is a method frequently used to price traditional mature stocks, but no digital currency is actually valued/priced using such fundamental valuation metrics.

Compare it directly with the other DEX tokens. One valuation metrics is the token market cap/daily trading volume ratio. This ratio ranges from 3–10x (Uniswap being a 7x). Because an active DEX’s daily transaction volume typically approaches the level of TVL, a DEX token market cap should be 3–10 times that of its TVL. This is what the digital currency market apparently applies to listed DEX tokens anyway. Measured by this metrics, the comparable market cap of TSC would be $30-$100 million, based on just the currently realized numbers instead of any future projections.

This means that TSC at the current market cap of $4 million is severely undervalued. Even if the TVL on the platform does not increase from the current level over the next 28 months (which would be a terrible outlook for a DEX platform), it would passively reach its fully diluted valuation (see above) based on the current token price, but the valuation could still be justified.

But to be successful, the platform must grow, and its TVL and trading pairs and activities increase. And when platform grows, the token price and the market cap should increase.

The future of TokenSwap lies on whether the size and volume of the platform increases to match the inflation over the time. The TSC payout is already maxed out according to the 30-month full dilution schedule, so they can’t attract new assets to farming by simply increasing payout. In any event, farming incentive payouts is really a temporary bootstrapping strategy, the effectiveness of which gradually decreases with time. The platform will need to attract more assets and users that want to trade intrinsically (rather than those who join to earn more farming payouts only).

TokenSwap started with BSV related liquidity pool pairs, but is not limited to trading pairs involving BSV coin. Although the technology is based on the BSV blockchain, in theory TokenSwap can create unlimited number of liquidity pools by bringing any tokens outside of the BSV blockchain to the platform. Any coin or token, BTC, ETH or any other tokens including those on Ethereum, can be brought to TokenSwap platform through a token bridge, which is already operating and expanding.

The challenges are in market recognition, as the entire BSV ecosystem suffers the same. The truth is not known, yet. Even most developers and digital currency influencers don’t understand this. The words need to be spread. And the outcome of the ongoing lawsuit Kleiman v. Wright will have a positive impact. See: In expectation of the historic Bitcoin trial: Kleiman v. Wright.

Economics aside, there is also a moral or ethical argument for supporting BSV-based applications such as TokenSwap. It’s utility. It’s truth. It’s honesty.

Disclaimer/Disclosure: This is absolutely not financial advice. I am just writing to express my own understanding of the system, mostly from a technical standpoint. I am not a fan in DeFi in general, and not even entirely sure of its legality in certain jurisdictions. With regard to TokenSwap specifically, because I am an early supporter and a holder of TSC tokens and liquidity pool shares on TokenSwap, my views are biased.

This article was lightly edited for clarity.

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https://www.youtube.com/watch?v=wGw6rBv7nlc&t=10734s