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This Startup Is on a Quest to Make Decentralized Exchanges Viable for Pros

The founders of the Vega Protocol believe that the concept of order book-based decentralized exchanges is not quite dead yet.

A key component of their quest to reinvigorate the concept was announced on Wednesday as a research paper. Titled “Market-Based Mechanisms for Incentivising Exchange Liquidity Provision,” the paper devises a method to overhaul the market making mechanism commonly found in centralized exchanges.

Cointelegraph spoke with Barney Mannerings and Tamlyn Rudolph, Vega’s co-founders, to learn more about their plans.

Incentivizing liquidity in a sustainable way

In traditional markets and centralized cryptocurrency exchanges, liquidity is often boosted through negotiated market making services. In the case of order book-based exchanges, they will enter into contracts that define rewards and obligations for each specific provider. “In my experience, normally it takes about a year to negotiate a bespoke contract,” Rudolph said.

Market making is a core component of traditional finance, and Rudolph explained that even though it depends on the liquidity profile, even highly liquid exchanges use these services.

Liquidity was one of the largest issues with previous iterations of decentralized exchanges, but since 2019 the rise of automated money markets like Bancor and Uniswap partially improved the situation.

Nevertheless, Mannerings appeared skeptical of their future prospects. He cited a paper published by Gauntlet, which concluded that “AMMs work because they have an order book-based venue that they can arbitrage against.” Furthermore, he believes that “it’s difficult to prove that yield farming can create a stable and long-lasting network effect.”

Vega’s proposed approach, in summary, relies on sharing fee revenue and combining that with the use of market forces to redistribute liquidity where needed. Mannerings explained that Vega’s system works by establishing the price of liquidity:

“The pric...
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