A New DeFi Exchange Says It Has Solved an Industry-Wide Problem

Decentralized exchange aggregator 1inch.exchange has launched its own DEX. As part of their efforts, they promised to fix two major issues with this type of exchange — front-running and impermanent loss.

Announced on Tuesday, the Mooniswap exchange is an automated market maker, or AMM, similar to Uniswap or Balancer.

It has adopted a distinctly different approach from Bancor V2, which uses oracles to stay updated on market prices.

Impermanent loss occurs when an asset’s price on an AMM slips compared to the going market rate on other exchanges. This intended behavior is how AMMs update prices, however their comparatively lower liquidity means that the slippage is rarely equal to the actual change in market prices.

Higher slippage opens opportunities for arbitrage traders to make up that difference by conducting the reverse trade. In essence, they extract a value in excess of the desired 50-50 balance, only returning the exchange fee of 0.3% to the liquidity pool. If the slippage amounts to 10%, a total of only 0.6% is returned to the pool as fees, while arbitrageurs pocket the remaining 9.4%.

Sergej Kunz, the CEO of 1inch.exchange, explained to Cointelegraph that arbitrage traders are the biggest earners in AMM protocols:

“The liquidity providers on Uniswap earn 0.3% on trading fees, let’s say $200,000 for a given period, while arbitrageurs earn $400,000 to $500,000.”

The team set out to fix this issue by trying to return more of the profit to liquidity providers instead of arbitrage traders. Kunz said that the team explored an oracle-based solution similar to Bancor, but found out that it is vulnerable to oracle front-running. “We realized that we need to fix the issue in a different way,” he said.

Inspired by a two year old post from Vitalik Buterin, they adopted the concept of virtual balances. When a high-slippage trade occurs, the internal balance of the exchange does not immediately reflect that change. At first, any new trade is still executed at the old price. 

Over a five minute period, the price gradually updates to its true value based on the pool balances. That opens small windows of arbitrage opportunities, which are expected to be taken as soon as possible.

The difference is that now the exchange fee takes a much higher percentage of the trader’s profit. Thus, the arbitrageurs return a much higher proportion of the price slippage to the pool.

In addition, any normal trader who is placing orders at the old price will be effectively returning a portion of that slippage difference to the pool, as they are technically overpaying for the trade.

Kunz said that the added benefit of this system is resistance to front-running. Since the price is not updated immediately, no profit can be obtained by being faster than someone else.

Concurrent with the launch, the 1inch team received a $2.8 million funding round led by Binance Labs and joined by Galaxy Digital, Dragonfly Capital, FTX, and others.