The principal advantage of decentralized cryptocurrency exchanges built on an underlying first-layer protocol is their interoperability with one another. Anton Bukov, CTO and co-founder of 1inch.exchange, told ForkLog Live at the online conference ‘DeFi: Instructions for Use’.
Layer-1 solutions are based on smart contracts, while Layer-2 solutions move part of the logic to sidechains and off-chain solutions.
To execute a trade on Layer-1, a user must create a transaction and wait for it to be mined into a block, which can take from a few seconds to minutes. On Layer-2, the main communication occurs with a server via signing. Confirmation takes a matter of milliseconds.
“The number of transactions that a first-layer DEX can process is limited by the blockchain’s throughput, and since Ethereum 1.0 lacks sharding, this is the total throughput for all DEXes at once. Each Layer-2 solution has its own throughput, higher due to data compression of transactions when relayed to the first layer,” explained Anton Bukov.
For the same reason, fees on Layer-2 solutions are cheaper.
“Since the start of the year, the cost of transactions on first-layer DEXs has risen by a hundredfold. Large swaps across several exchanges cost hundreds of dollars,” notes the expert.
However, despite the apparent advantages of Layer-2 solutions, they show low viability, adds Bukov:
“The so-called ‘chicken and egg’ problem: there are no users because there are no good prices, and there are no good prices because there are no users. By comparison, in 2020 more than five different Layer-1 solutions were launched and most of them are alive and functioning.”
The main reason for the success of Layer-1 protocol solutions is their interoperability with each other and with other DeFi components.
“When we work with a smart contract, we can reach to it from another smart contract and change something. The contract allows atomically performing complex operations. At the same time, exchange between first- and second-layer exchanges is not possible,” says the CTO of 1inch.exchange.
He added that a user of a Layer-2 exchange would have to make a deposit on the exchange, and with a signature notify the intent to conduct a trade or withdraw funds. This will happen only when the operator of that DEX provides compressed data to the blockchain, which, evidently, will take a long time:
“On the first layer, the property of interoperability allows working with all exchanges in one transaction. That is why such solutions grow well; you can interact with them constantly. Complex paths are possible only on the first layer,” summarized Anton Bukov.
Join the online conference ‘DeFi: Instructions for Use’ on ForkLog Live.