Phoenix: Revolutionizing DeFi with Crankless Order Books on Solana

In the rapidly evolving world of decentralized finance (DeFi), innovation is the key to staying ahead. One project that's been making waves in the Solana ecosystem is Phoenix, a groundbreaking on-chain order book developed by Ellipsis Labs. In a recent episode of the Validated podcast, host Austin sat down with Jarry Xiao from Ellipsis Labs to discuss the intricacies of Phoenix and its potential to reshape the DeFi landscape.

The Genesis of Phoenix

Phoenix emerged from a critical analysis of existing DeFi solutions and their limitations. Jarry Xiao, drawing from his background in high-frequency trading, recognized that traditional finance markets operate primarily on order books, a model that had not been successfully replicated in the DeFi space due to various constraints.

The journey of Phoenix begins with an understanding of the shortcomings of automated market makers (AMMs) like Uniswap, which have dominated the DeFi landscape since 2017. While AMMs introduced a novel approach to on-chain trading, they diverged significantly from how traditional financial markets operate.

Traditional Finance vs. AMMs

In traditional finance, markets predominantly use central limit order books. These order books allow buyers and sellers to place orders at specific prices, creating a dynamic environment where market participants can react quickly to changing conditions. This model has proven highly efficient in handling large volumes and facilitating price discovery.

Conversely, AMMs like Uniswap rely on mathematical equations to determine token prices and execute trades. While this approach was innovative and well-suited to the computational limitations of early blockchain networks, it lacks the flexibility and efficiency of traditional order books.

Jarry explains, "In traditional finance, markets don't really work like Uniswap V2 or Uniswap V1. The design there is effectively, you have this math equation that governs the way that the price moves around and the amount of tokens you get when you make a trade."

The Solana Advantage

The emergence of high-performance blockchain networks like Solana has opened up new possibilities for on-chain trading. Solana's high throughput and low fees make it possible to implement more sophisticated trading mechanisms that were previously impractical on other blockchains.

Jarry highlights two critical factors that make Solana an ideal platform for order book-based trading:

1. Low fees: Enabling market makers to place and cancel orders frequently without incurring prohibitive costs.
2. High throughput: Allowing for rapid updates to order books, closely tracking real-time price movements.

These characteristics address the fundamental challenges that prevented order books from being viable on earlier blockchain platforms.

The Importance of Low Fees

In traditional finance, placing and canceling orders is typically free, allowing market makers to adjust their positions rapidly in response to changing market conditions. On blockchain networks with high transaction fees, this becomes economically unfeasible.

Jarry elaborates, "If it costs $1 to cancel and you need to place a thousand quotes an hour, effectively, if your revenue model doesn't allow you to make more than that, sufficiently more than that, it just makes no sense to provide liquidity in the first place."

Solana's low fees make it economically viable for market makers to actively manage their positions, closely mirroring the dynamics of traditional financial markets.

The Significance of High Throughput

High throughput is crucial for maintaining price alignment between on-chain and off-chain markets. Most major cryptocurrencies see their primary price discovery happen on centralized exchanges. A blockchain with long block times will inevitably see its on-chain prices deviate from the "true" prices on centralized venues.

Solana's rapid block times allow for frequent updates to order books, minimizing the risk of significant price discrepancies. This feature is essential for reducing the likelihood of adverse selection, where market makers are caught with stale quotes when prices move rapidly.

The Problem with Cranks

Before delving into Phoenix's innovations, it's important to understand the limitations of previous on-chain order book implementations, particularly Serum. Serum introduced the concept of "cranks" to handle trade settlement.

In Serum's model, when a trade is executed, it enters a pending state. A third-party service, known as a cranker, is required to process these pending trades and finalize settlements. This introduces a delay between trade execution and settlement, creating potential issues for traders and market makers.

Jarry describes the crank system as "a massive speed bump" in what should be a seamless trading process. He adds, "To me, this feels like just like flaw design, where if you can avoid this, that's probably gonna make the experience for all the users... a lot easier."

Phoenix's Crankless Design

Phoenix's most significant innovation is its crankless design. By eliminating the need for asynchronous settlement processes, Phoenix offers a more efficient and user-friendly trading experience.

The key to Phoenix's crankless design lies in its novel approach to handling user balances. Instead of maintaining separate accounts for each user, Phoenix utilizes a single account per market that contains everyone's balance information.

Jarry explains, "With Phoenix's design, effectively we say instead of having one open orders account for every user, we have one per market. So that one just contains everyone's information."

This architectural change allows for immediate settlement of trades without the need for external cranking processes. As soon as a trade is executed, the balances of all involved parties are updated within the same transaction, eliminating the settlement delays inherent in previous designs.

Capital Efficiency: Phoenix vs. AMMs

One of the most striking advantages of Phoenix's order book model is its capital efficiency. Traditional AMMs require large amounts of locked liquidity to function effectively, often resulting in poor capital utilization.

Phoenix, on the other hand, demonstrates significantly higher capital efficiency. Jarry notes, "If you think about the ratio between volume and liquidity, Phoenix is way, way, way higher."

This efficiency is reflected in Phoenix's Total Value Locked (TVL) figures, which are substantially lower than those of comparable AMMs, despite handling similar trading volumes. This indicates that Phoenix can facilitate a high volume of trades with less capital locked in the protocol, potentially leading to better returns for liquidity providers.

The Market Maker's Perspective

A unique aspect of Phoenix's philosophy is its focus on catering to market makers. While many DeFi protocols prioritize the taker side of trades, Phoenix recognizes the crucial role that market makers play in creating efficient markets.

Jarry states, "We think that the market maker is the most important participant." This perspective drives Phoenix's development, with a focus on creating features and tools that make life easier for market makers.

The rationale behind this approach is that by providing a better environment for market makers, the overall market quality improves, ultimately benefiting all participants. Better liquidity and tighter spreads lead to a better experience for takers as well.

Future Developments: Phoenix V2

Looking ahead, the Ellipsis Labs team is already working on the next iteration of Phoenix. While still in the ideation phase, Phoenix V2 aims to introduce further innovations to enhance the trading experience.

One area of focus is the introduction of programmable orders with pre-effects and side effects. This could allow for more sophisticated trading strategies to be implemented directly within the order book, potentially giving market makers more tools to manage risk and provide liquidity efficiently.

Jarry hints at the direction of these developments: "If you can write some-- effectively program your orders to be a little bit smarter against some of these situations, and it's very clear to me that you can't solve everything. You can't write a hook that will prevent you from getting picked off ever. But it's possible to be in right-- these helpful things inside the matching engine to give these market makers a little bit of a boost."

The Role of Aggregators

The discussion also touched on the importance of aggregators in the DeFi ecosystem, particularly highlighting Jupiter's role in the Solana ecosystem. Aggregators play a crucial role in directing flow to various DEXes, creating a competitive environment that benefits end-users.

Jarry acknowledges the positive impact of aggregators: "I think it's been really positive for all-spot decks is that there is this like number one aggregator to go to. It really does make a lot of sense. Because now you kind of have like intra-deck competition to provide better prices for the takers."

This competition drives innovation and efficiency across the ecosystem, pushing protocols like Phoenix to continually improve their offerings.

Phoenix's Approach to Trading Pairs

Unlike some other DEXes that offer a vast array of trading pairs, Phoenix has taken a more curated approach. While the protocol is permissionless, allowing anyone to launch a new pair, the team has focused on supporting a smaller number of high-quality, liquid pairs.

This strategy aligns with Phoenix's focus on capital efficiency and market maker-friendly design. By concentrating liquidity in key pairs, Phoenix can offer better execution and tighter spreads for the most important trading pairs in the ecosystem.

The Impact of Interest Rates

An interesting point of discussion was the impact of rising interest rates on market making activities. Contrary to what some might expect, Jarry suggests that the shift from a 0% to a 5% interest rate environment hasn't significantly affected market making on Phoenix.

He explains, "I don't think people are primarily like borrowing capital to market make. I think most people for spot, especially on spot decks, are basically just using inventory they already have."

This insight suggests that the market making activities on Phoenix are primarily driven by firms and individuals using their existing cryptocurrency holdings, rather than leveraged positions.

The Future of DeFi on Solana

The success and innovation demonstrated by Phoenix highlight the potential for sophisticated financial primitives to thrive on high-performance blockchains like Solana. As the DeFi ecosystem continues to evolve, projects like Phoenix are pushing the boundaries of what's possible in on-chain trading.

The crankless design, focus on capital efficiency, and market maker-centric approach of Phoenix represent a significant step forward in the maturation of DeFi. These innovations bring on-chain trading closer to the efficiency and sophistication of traditional financial markets while maintaining the benefits of decentralization and transparency.

Conclusion

Phoenix stands as a testament to the rapid innovation happening in the Solana ecosystem. By addressing key limitations of previous DEX designs and leveraging Solana's unique capabilities, Phoenix has created a trading venue that offers unparalleled efficiency and user experience in the DeFi space.

As the project continues to evolve, with plans for Phoenix V2 on the horizon, it's clear that Ellipsis Labs is committed to pushing the boundaries of what's possible in on-chain trading. The focus on market makers, capital efficiency, and technological innovation positions Phoenix as a key player in the future of decentralized finance.

For traders, developers, and DeFi enthusiasts looking to stay at the forefront of innovation, Phoenix and the broader Solana ecosystem offer exciting opportunities to engage with cutting-edge financial technology. As the DeFi landscape continues to mature, projects like Phoenix will play a crucial role in bridging the gap between traditional finance and the decentralized future of markets.

Facts + Figures

• Phoenix is an on-chain order book developed by Ellipsis Labs for the Solana blockchain.
• Phoenix's crankless design eliminates the need for asynchronous settlement processes, improving efficiency.
• The protocol uses a single account per market to contain all users' balance information, enabling immediate trade settlement.
• Phoenix demonstrates significantly higher capital efficiency compared to traditional AMMs, with a higher volume-to-liquidity ratio.
• The Total Value Locked (TVL) in Phoenix is lower than comparable AMMs, despite handling similar trading volumes.
• Phoenix focuses on market makers as the most important participants in the trading ecosystem.
• The project is permissionless, allowing anyone to launch new trading pairs.
• Most market makers on Phoenix use their existing inventory rather than borrowed capital.
• Ellipsis Labs is working on Phoenix V2, which aims to introduce programmable orders with pre-effects and side effects.
• The shift from a 0% to 5% interest rate environment hasn't significantly affected market making on Phoenix.
• Phoenix's development is driven by Solana's low fees and high throughput capabilities.
• The project's Twitter page is @PhoenixTrade, and GitHub activity can be tracked under Ellipsis Labs.

Questions Answered

What is Phoenix?

Phoenix is an innovative on-chain order book developed by Ellipsis Labs for the Solana blockchain. It offers a crankless design that eliminates the need for asynchronous settlement processes, enabling immediate trade execution and settlement. Phoenix aims to provide a more efficient and capital-effective trading experience compared to traditional automated market makers (AMMs) in the DeFi space.

How does Phoenix's crankless design work?

Phoenix's crankless design operates by using a single account per market that contains all users' balance information, rather than maintaining separate accounts for each user. This architectural change allows for immediate settlement of trades within the same transaction as the trade execution. When a trade occurs, the balances of all involved parties are updated instantly, eliminating the need for external cranking processes and reducing settlement delays.

Why is Phoenix more capital efficient than traditional AMMs?

Phoenix demonstrates higher capital efficiency than traditional AMMs due to its order book model. While AMMs require large amounts of locked liquidity to function effectively, Phoenix can facilitate a high volume of trades with less capital locked in the protocol. This is evidenced by Phoenix's lower Total Value Locked (TVL) figures compared to AMMs handling similar trading volumes, indicating better utilization of capital and potentially leading to improved returns for liquidity providers.

How does Phoenix cater to market makers?

Phoenix prioritizes market makers by focusing on creating features and tools that improve their trading experience. This includes the crankless design, which allows for faster and more efficient order placement and cancellation. The team is also working on introducing programmable orders with pre-effects and side effects in Phoenix V2, which could provide market makers with more sophisticated tools to manage risk and provide liquidity efficiently. By creating a better environment for market makers, Phoenix aims to improve overall market quality and liquidity.

What role does Solana play in enabling Phoenix's functionality?

Solana's high-performance blockchain is crucial for Phoenix's functionality. The network's low fees make it economically viable for market makers to actively manage their positions by frequently placing and canceling orders. Additionally, Solana's high throughput and rapid block times allow for frequent updates to order books, minimizing the risk of significant price discrepancies between on-chain and off-chain markets. These features address fundamental challenges that prevented order books from being viable on earlier blockchain platforms.

How does Phoenix compare to previous on-chain order book implementations like Serum?

Phoenix improves upon previous implementations like Serum by eliminating the need for "cranks" in the settlement process. While Serum required third-party services to process pending trades and finalize settlements, Phoenix's design allows for immediate settlement within the same transaction as the trade execution. This removes delays between trade execution and settlement, creating a more seamless trading experience for users and market makers.

What are the plans for Phoenix V2?

While still in the ideation phase, Phoenix V2 aims to introduce further innovations to enhance the trading experience. The team is exploring the introduction of programmable orders with pre-effects and side effects, which could allow for more sophisticated trading strategies to be implemented directly within the order book. These developments are focused on giving market makers more tools to manage risk and provide liquidity efficiently, ultimately improving the overall trading ecosystem.

How has the changing interest rate environment affected market making on Phoenix?

According to Jarry Xiao, the shift from a 0% to a 5% interest rate environment hasn't significantly affected market making activities on Phoenix. Most market makers on the platform are using their existing cryptocurrency holdings rather than borrowed capital for their activities. This suggests that the market making on Phoenix is primarily driven by firms and individuals leveraging their own inventory, rather than relying on leveraged positions that might be more sensitive to interest rate changes.