CoinList Seed: Nillion’s Winning Presentation

PUBLISHED

11.30.2023

AUTHOR

Mark McDermott

CATEGORY

Tech Updates

The emergence of Bitcoin DeFi will spark a revolution for Web3 developers, opening the doors to harness Bitcoin’s unparalleled network strength and liquidity in innovative ways. For Web3 developers, this isn’t just another chapter in the story of DeFi—it’s an entirely new book waiting to be written.

Bitcoin has a number of admirable qualities:

  • Deep liquidity
  • High security budget
  • Completely decentralized
  • Fixed money supply
  • Durable—Bitcoin has survived and thrived in the last 15 years

For all these reasons, Bitcoin should be the base layer for Web3. But it isn’t.
Because of the lack of smart contracts on the Bitcoin blockchain, Bitcoin has been used purely as a store of value, while its integration into finance—as a money, currency, and capital asset—has lagged.

That’s now changing with Bitcoin layers, which enable devs to build DeFi in the Bitcoin ecosystem. So if you are a developer building on Bitcoin, what do you need to know about DeFi to build your own applications?

We covered the DeFi 101 basics previously, but here we’re going to go deeper into decentralized exchanges. Decentralized exchanges (DEXs) have become the hallmark of DeFi due to their ability to provide users with trustless, permissionless, and non-custodial trading, and we’ll cover two mechanisms that enable them to work: liquidity pools and automated market makers (AMMs).

What Is a Liquidity Pool?

At the heart of DeFi is the DEX, and at the heart of the DEX is a liquidity pool. A liquidity pool is a set of two or more cryptocurrencies locked into a smart contract. When a user trades one asset for another using a DEX, it’s the liquidity pool underneath that provides the user the new token they swap for.

Liquidity refers to the ease and speed with which you can turn one asset into another. When liquidity is high, it benefits traders. For example, the depth of a pool (its total value) determines how well it can handle “price slippage” during individual trades. Price slippage is the difference between the expected trade price and the actual execution price. An “illiquid” pool, one with a low total value, struggles to accommodate large trades without depleting its assets at the quoted price. This leads to less efficient and costlier transactions.

Liquidity Providers (LPs) add assets to a pool and receive an LP token, which are claims of ownership on the value in that pool and can be redeemed for assets in the pool at a later date.

Order Books vs Automated Market Makers

At the heart of DeFi is the DEX, and at the heart of the DEX is a liquidity pool. A liquidity pool is a set of two or more cryptocurrencies locked into a smart contract. When a user trades one asset for another using a DEX, it’s the liquidity pool underneath that provides the user the new token they swap for.

Liquidity refers to the ease and speed with which you can turn one asset into another. When liquidity is high, it benefits traders. For example, the depth of a pool (its total value) determines how well it can handle “price slippage” during individual trades. Price slippage is the difference between the expected trade price and the actual execution price. An “illiquid” pool, one with a low total value, struggles to accommodate large trades without depleting its assets at the quoted price. This leads to less efficient and costlier transactions.

Liquidity Providers (LPs) add assets to a pool and receive an LP token, which are claims of ownership on the value in that pool and can be redeemed for assets in the pool at a later date.

Exploring DEXs on Bitcoin

At the heart of DeFi is the DEX, and at the heart of the DEX is a liquidity pool. A liquidity pool is a set of two or more cryptocurrencies locked into a smart contract. When a user trades one asset for another using a DEX, it’s the liquidity pool underneath that provides the user the new token they swap for.

Liquidity refers to the ease and speed with which you can turn one asset into another. When liquidity is high, it benefits traders. For example, the depth of a pool (its total value) determines how well it can handle “price slippage” during individual trades. Price slippage is the difference between the expected trade price and the actual execution price. An “illiquid” pool, one with a low total value, struggles to accommodate large trades without depleting its assets at the quoted price. This leads to less efficient and costlier transactions.

Liquidity Providers (LPs) add assets to a pool and receive an LP token, which are claims of ownership on the value in that pool and can be redeemed for assets in the pool at a later date.