#DPOS "Delegated Proof of Stake" versus #POW "Proof of Work" as the blockchain for a decentralized exchange
Today I am writing about my experience with decentralized exchanges, and analyzing the reasons for the big difference in profits for Liquidity Providers on a DPOS chain versus a POW chain.
I have recently experienced being a Liquidity Provider on each and wanted to share my experiences and conclusions.
While these are the experiences of a single trader, I want to share my thoughts and ask others for their thoughts, so we can all learn.
DPOS
Pros:
These blockchains provide fast free transactions, as advertised, so for the trader they are a preferred platform.
Cons:
There seems to be a limited number of high profile or high market cap coins available on the platforms I used.
For the Liquidity provider, lower transaction fees meant smaller profits for Liquidity Providers, which are divide amongst all liquidity providers in the pool.
I think the profit size didn't justify the risk loss of my capitol, so I withdrew my funds.
My Suggestions:
For these Liquidity Pools to be profitable for Liquidity Providers, the wrapped token creators will need to provide rewards or incentives to Liquidity Providers to invest beyond the transaction fees.
POW
Pros:
These Liquidity Pools provide a larger variety of top market cap coins.
These Liquidity Pools charge higher transactions fees to traders, so the profits to Liquidity Pool providers are higher.
The Liquidity Pools provide rewards in ETH, a very desirable Token.
Cons
These Liquidity Pools charge higher transactions to traders, so they increase the costs, thus lower the profits for traders.
Transaction speed for Pools on older POW blockchains are slower versus faster, newer DPOS blockchains.
Suggestions for DEX on POW chain:
These are preferred places to trade, so if hardware fixes or software fixes could increase speeds and if mining fees can be lowered in exchange perhaps for increased volume the cost to traders would be lowered, while maintaining income to miners and increasing profits for traders.
Suggestions for DEX on DPOS chain
The Liquidity Pool projects on DPOS chains appear to have much smaller transaction fees, which the main source of profits for Liquidity Providers. So the teams which wrap tokens for trading on these DEX need to provide additional incentives for Liquidity Providers.
This can be in the for of wrapped token rewards or another token. But transaction fees alone are insufficient to justify risk.
Additional observations for investors on DPOS chain DEX
So far the DPOS DEX AMM have some projects with large APR rewards advertised, but this appears to mainly benefit initial investors; the first ones into the pool.
Why?
These profits were provided mainly by Pool incentives of large initial APR allowed large token rewards to small numbers of early investors, as the rewards were divided amongst fewer liquidity providers. Once the pools had large amounts of liquidity, and a corresponding large number of investors, the large APR rewards became very small. It’s a math issue. 100 divided by 10 is 10 tokens, but 100 divided by 1000 is 1/10th of a token.
Additionally as the numbers of Liquidity Providers rose, the small profits generated by the naturally lower transaction fees of a DPOS blockchain meant that total profits available for Liquidity Providers shrank when divided amongst the increasing number of investors and the risk becomes greater than reward to a Liquidity Provider.
This isn't a criticism of DPOS, it is an observation of profit potential for Liquidity Providers and hopefully a illustration of some of the hurdles faced by DPOS chain projects.
Last thoughts
We all want fast, free transactions, but due to the lack of profits to Liquidity Providers on the DPOS blockchain, but I think the transaction fees alone don’t provide enough profit to surpass risk of capitol loss to liquidity providers. I think additional incentives will be needed for DPOS chains as their tokens are of lower value. But I am unfamiliar with any DEX on EOS, where the numbers might be different.