Loopring: A Decentralized Token Exchange Protocol

1 Loopring: A Decentralized Token Exchange ProtocolDaniel 8, 2018 AbstractLoopring is an open Protocol for building Decentralized exchanges. loopring operates as a public set of smartcontracts responsible for trade and settlement, with an off-chain group of actors aggregating and communicating Protocol is free, extensible, and serves as a standardized building block for Decentralized applications (dApps) thatincorporate Exchange functionality. Its interoperable standards facilitate trustless, anonymous trading. An importantimprovement over current Decentralized Exchange protocols is the ability for orders to be mix-and-matched with other,dissimilar orders, obviating the constraints of two- Token trading pairs and drastically improving liquidity. Loopringalso employs a unique and robust solution to prevent front-running: the unfair attempt to submit transactions into ablock quicker than the original solution provider. loopring is blockchain agnostic, and deployable on any blockchainwith smart contract functionality.

2 At the time of writing, it s operable on Ethereum [1] [2] and Qtum [3] with NEO [4]under IntroductionWith the proliferation of blockchain-based assets, the needto Exchange these assets amongst counterparties has signifi-cantly increased. As thousands of new tokens are introduced- including the tokenization of traditional assets - this needis magnified. Whether exchanging tokens for speculativetrading motivations, or converting to access networks viatheir native utility tokens, the ability to Exchange one cryp-toasset for another is foundational for the larger , there is a potential energy in assets [5], and realizingthis energy - unlocking capital - requires not only assertingownership, which blockchains have immutably allowed for,but the ability to freely transfer and transform these such, the trustless Exchange of tokens (value) is acompelling use case for blockchain technology. Until now,however, crypto enthusiasts have largely settled for tradingtokens on traditional centralized exchanges.

3 The Loopringprotocol is needed because, just as Bitcoin [6] dutifullyemphasized that, in regards to peer-to-peer electronic cash, the main benefits are lost if a trusted third party is stillrequired to prevent double-spending , so too are the mainbenefits of Decentralized assets lost if they must pass throughtrusted, gated, centralized Decentralized tokens on centralized exchangesdoesn t make sense from a philosophical perspective, asit fails to uphold the virtues these Decentralized projectsespouse. There are also numerous practical risks and lim-itations in using centralized exchanges which are describedbelow. Decentralized exchanges (DEXs) [7] [8] [9] havesought to address these issues, and in many cases havesucceeded in alleviating security risks by using blockchainsfor disintermediation. However, as DEX capability becomescrucial infrastructure for the new economy, there is substan-tial room for performance improvement.

4 loopring aims toprovide modular tools for said infrastructure with its dAppagnostic open Current Exchange Inadequacies of Centralized ExchangesThe three primary risks of centralized exchanges are; 1) Lackof security, 2) Lack of transparency, and 3) Lack of of Securityarises from users typically surrender-ing control of their private-keys (funds) to one centralizedentity. This exposes users to the possibility that centralizedexchanges fall prey to malicious hackers. The security andhacking risks facing all centralized exchanges are well known[10] [11], yet are often accepted as table stakes for tokentrading. Centralized exchanges continue to be honeypots for1hackers to attack as their servers have custody over millionsof dollars of user funds. Exchange developers can also makehonest, accidental errors with user funds. Simply, usersare not in control of their own tokens when deposited ata centralized of Transparencyexposes users to the risk ofdishonest exchanges acting unfairly.

5 The distinction here isby the Exchange operator s malicious intentions, as users arenot truly trading their own assets on centralized exchanges,but rather, an IOU. When tokens are sent to the Exchange swallet, the Exchange takes custody, and offers an IOU in itsplace. All trades are then effectively between users withdraw, users redeem their IOU with the Exchange ,and receive their tokens to their external wallet this process there is a lack of transparency,and the Exchange can shutdown, freeze your account, gobankrupt, etc. It is also possible that they use user assetsfor other purposes while in custody, such as lending themout to third parties. Lack of transparency can cost userswithout a total loss of funds, such as in higher trading fees,delays at peak demand, regulatory risk, and orders beingfront of the point of view of exchangeoperators, fragmented liquidity inhibits entry by new ex-changes because of two winner-takes-all scenarios.

6 First, theexchange with the greatest number of trading pairs wins,because users find it desirable to conduct all their trades onone Exchange . Second, the Exchange with the largest orderbook wins, because of favorable bid-ask spreads for eachtrading pair. This discourages competition from newcomersbecause it is difficult for them to build up initial a result, many exchanges command a high market sharedespite user complaints and even major hacking s worth noting that as centralized exchanges win marketshare, they become an ever-larger hacking the point of view of users, fragmented liquiditysignificantly reduces user experience. In a centralized ex-change, users are only able to trade within the Exchange sown liquidity pools, against its own order book, and be-tween its supported Token trade tokenAfortokenB, users must go to an Exchange that supports bothtokens or register at different exchanges, disclosing personalinformation.

7 Users often need to execute preliminary orintermediate trades, typically against BTC or ETH, payingbid-ask spreads in the process. Finally, the order books maynot be deep enough to complete the trade without materialslippage. Even if the Exchange purports to process largevolumes, there is no guarantee that this volume and liquidityis not fake [12].The result is disconnected silos of liquidity and a frag-mented ecosystem that resembles the legacy financial sys-tem, with significant trading volume centralized on fewexchanges. The global liquidity promises of blockchains holdno merit within centralized Inadequacies of Decentralized Ex-changesDecentralized exchanges differ from centralized exchangesin part because users maintain control of their private-keys(assets) by performing trades directly on the underlyingblockchain. By leveraging the trustless technology of cryp-tocurrencies themselves, they successfully mitigate many ofthe abovementioned risks surrounding security.

8 However,problems persist in regards to performance and often remains an issue as users must searchfor counterparties across disparate liquidity pools and stan-dards. Fragmented liquidity effects are present if DEXsor dApps at large don t employ consistent standards tointeroperate, and if orders are not shared/propagated acrossa wide network . The liquidity of limit order books, and,specifically, their resiliency how fast filled limit ordersare regenerated can significantly affect optimal tradingstrategies [13]. The absence of such standards has resultednot only in reduced liquidity, but also exposure to an arrayof potentially insecure proprietary smart , since trades are performed on chain, DEXsinherit the limitations of the underlying blockchain, namely:scalability, delays in execution (mining), and costly modifi-cations to orders. Thus, blockchain order books do not scaleparticularly well, as executing code on the blockchain incursa cost (gas), making multiple order-cancellation cadencesprohibitively , because blockchain order books are public, thetransaction to place an order is visible by miners as it awaitsbeing mined into the next block and placed into an orderbook.

9 This delay exposes the user to the risk of being frontrun and having the price or execution move against Hybrid SolutionsFor the above reasons, purely blockchain-based exchangeshave limitations that make them uncompetitive with cen-tralized exchanges. There is a tradeoff between on-chaininherent trustlessness, and centralized Exchange speed andorder flexibility. Protocols such as loopring and 0x [14]extend a solution of on-chain settlement with off-chain ordermanagement. These solutions revolve around open smartcontracts, but navigate scalability limitations by performingseveral functions off-chain and giving nodes flexibility infulfilling critical roles for the network . However, drawbacksremain for the hybrid model as well [15]. The Loopringprotocol proposes meaningful differences in our approach toa hybrid solution throughout this loopring ProtocolLoopring is not a DEX, but a modular Protocol for buildingDEXs on multiple blockchains.

10 We disassemble the compo-nent parts of a traditional Exchange and offer a set of public2smart contracts and Decentralized actors in its place. Theroles in the network include wallets, relays, liquidity-sharingconsortium blockchains, order book browsers, Ring-Miners,and asset tokenization services. Before defining each, weshould first understand loopring Order RingLoopring orders are expressed in what we call a Unidirec-tional Order Model (UDOM)[16]. UDOM expresses ordersas Token Exchange requests,amountS/amountB, (amount tosell/buy) instead of bids and asks. Since every order is justan Exchange rate between two tokens, a powerful feature ofthe Protocol is the mixing and matching of multiple orders incircular trade. By using up to 16 orders instead of a singletrading pair, there is a dramatic increase in liquidity andpotential for price #2owner: YamountS: 9 BamountB: 12 CORDER#1owner: XamountS: 10000 AamountB: 2 BORDER#3owner: ZamountS: 100 CamountB: 160A7898A8B98 CFigure 1: An order-ring of 3 ordersThe above figure shows an order-ring of 3 orders.