1inch: The Decentralized Exchange Aggregator

Benefits of the 1inch Exchange Protocol

1inch is an aggregator that scans decentralized exchanges (DEXs) to find the lowest cryptocurrency prices for traders. To understand the value of 1inch, you need an intermediate understanding of markets as a whole, and particularly cryptocurrency. Secondary markets, also known as exchanges, play a crucial role in the digital asset ecosystem facilitating the transfer of tokens between parties. Cryptocurrency exchanges fall into two categories depending on their underlying infrastructure: centralized exchanges and decentralized exchanges.

Centralized crypto exchanges (CEXs) use order books to match buyers and sellers on the open market. These platforms custody your crypto, holding your assets in an exchange-based wallet — similar to traditional securities trading platforms. In contrast, decentralized exchanges employ self-executing smart contracts to match and execute transactions between buyers and sellers using non-custodial infrastructure.

However, while DEXs offer greater security and autonomy, a lack of liquidity can result in what is known as slippage, an inefficiency in the pricing of assets that results in a difference between the expected price of a trade and the actual price of the trade when executed. DEX aggregators like 1inch aim to deepen liquidity pools by scanning a range of DEXs to find the lowest market price to facilitate a trade. By breaking down the functional differences between centralized and decentralized exchanges further, we can begin to understand the impact 1inch has on liquidity.

Why Decentralized Exchanges Lack Liquidity

Centralized crypto exchanges unify all trading activity in one central marketplace. The benefit of this infrastructure is that users obtain access to a greater number of trading partners. When more buyers and sellers come together, traders can enter (buy) or exit (sell) positions more readily and at desirable market prices. As such, their investments are more liquid, or readily convertible. Deep liquidity is preferable because it allows traders to remain agile and responsive to market movements. In short, liquidity helps protect against negative market pressure and improves money mobility.

Compared to centralized exchanges, decentralized exchange protocols use different strategies to ensure liquidity without the need for a central custodian. In the absence of order books and matching engines, many DEX platforms utilize automated market makers (AMMs) to facilitate transactions via liquidity pools. These pools operate using smart contracts that dictate the conditions of each trading pair. However, because these transactions occur on-chain, they are subject to variable gas fees. In times of high network congestion, gas fees rise rapidly, disincentivizing trading activity and putting negative pressure on liquidity.

Further, many blockchain networks can't support the trading volume necessary to achieve the depth of liquidity found on centralized exchanges. While decentralized platforms like Binance Chain and Solana avoid high gas fees on the Ethereum network by employing atomic swaps, they don't support ERC-20 tokens, which is problematic given that a vast majority of cryptocurrencies in circulation today adhere to this standard. Collectively, these shortcomings inherent to centralized exchanges highlight the need for protocols like the 1inch DEX aggregator.

How the 1inch Exchange Deepens Liquidity to Reduce Slippage

Slippage occurs when insufficient trading volume results in purchasing an asset for more than was originally intended or the selling of an asset for less than was originally intended. The 1inch DEX protocol aggregates liquidity across DEX platforms to deepen DEX liquidity, which counteracts order slippage.

As an example, let's say an institutional investor wanted to buy 1,000 BTC at $50,000/BTC. However, only 500 BTC is available on this particular decentralized exchange when the buy order hits the open market. As a result, the exchange moves on to the next sell order set at $50,500/BTC. In this case, the buyer paid $250,000 ($500 per BTC x 500 BTC) more than they originally intended. This is slippage. The 1inch protocol helps to avoid this scenario by merging trading activity together across several platforms, thus pooling liquidity and minimizing market inefficiencies like slippage.

In November of 2020, 1inch launched v2 of its protocol, enabling swaps across 21 decentralized exchanges. In addition to counteracting slippage on individual trades, the protocol also indirectly buffers price volatility across the broader DEX ecosystem by increasing liquidity across the broader market.

The 1INCH Crypto Token Ecosystem

Liquidity on 1inch is also bolstered by the 1inch Liquidity Protocol, an AMM that uses virtual balances to decrease impermanent loss. Users can benefit from providing tokens as liquidity on the 1inch DEX platform — a process that’s called “liquidity mining” — whereby traders provide assets like ETH to a specific pool, lock it in, and earn 1INCH, the native token of 1inch, as interest. This model is similar to native DEX tokens like Uniswap’s UNI, and incentivizes community-based liquidity provision.

In addition to furnishing the 1inch AMM Liquidity protocol, the 1INCH token is central to 1inch governance. The 1INCH token was distributed on Christmas Day of 2020 as a governance token retroactively disbursed to users of the 1INCH exchange platform. As a governance token, 1INCH tokens come with equal voting rights in 1INCH’s decentralized governance administration. The distribution was retroactive because the tokens were guaranteed to users of the platform prior to the token launch itself.

In total, those meeting the following criteria received their share of the 90 million 1INCH tokens:

• Anyone who made at least one trade before September 15, 2020;

• or at least four trades in total;

• or any number of trades equal to a total of $20.

Of the 1.5 billion tokens minted, 6% were distributed during the initial 1INCH airdrop. Of the remaining supply, 14.5% of 1INCH tokens will be unlocked over fours years to support team expansion, audits, grants, and insurance against potential hacks. Another 23% of 1INCH tokens will be a source of funding for community incentives, including the 1inch Liquidity Protocol.

The 1inch token ecosystem also features the Chi Gastoken, a functional token that 1inch users can use to pay for transaction costs. The Chi Gastoken is a tokenized ERC-20 token pegged to the cost of gas on Ethereum that increases efficiency on the network. Users are incentivized to use it through discounts on fees for trades.

1inch Exchange: Instant Governance

The 1INCH token represents voting rights and facilitates participation in the decentralized autonomous organization (DAO) that governs the 1inch DEX platform. While DAOs are relatively common in the cryptocurrency industry and in DeFi in particular, the 1inch exchange employs a governance model known as "instant governance." This proprietary model makes it easier for token holders to make changes to the protocol.

The 1inch Foundation asserts that instant governance offers holders more ownership of the platform by allowing everyone to participate in the governance process — every vote counts and there are no advantages for select token holders. This model contrasts with the DAO in use on the Dash platform, for example, where Masternodes have special voting rights over all others on the network.

Even with the DeFi ecosystem growing more vast by the day, 1inch stands out, providing a unified access point to decentralized exchanges and various tokens. By pooling the liquidity of the wider DeFi sector and providing a native source of liquidity via its AMM, 1inch is on the path to opening the floodgates of liquidity in the decentralized finance (DeFi) ecosystem.