How do you pick the best exchange rate for cryptocurrencies? On centralized exchanges (CEXs), the difference is often minimal because CEXes tend to have deep liquidity. But on decentralized exchanges (DEXs), which rely on network participants and fees, the exchange rate is meaningful.
This is where a DEX aggregator like 1inch comes in. The exchange draws swap rates from other DEXs to find both the optimal price and the lowest fees.
1inch Origin and Purpose
Sergej Kunz and Anton Bukov came up with the concept of smart contract aggregation during the ETHGlobal hackathon in May 2019. Bukov had software development experience in NEAR Protocol, while Kunz worked for Mimacom, a cybersecurity consultancy.
Kunz developed a text message aggregator that allowed users to see the best rates for sending text messages. This led to his employment at the Herzog communication and marketing agency, having developed a product price aggregator. Following his full employment at Porsche, Kunz became an Ethereum miner all the way up to 2018 when he launched.
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The two hit it off at CryptoManiacs, a YouTube channel with over 11k subscribers, where they audited smart contracts. The pair came up with the idea of a DEX aggregator during the hackathon. The concept was based on Kunz’s previous work on arbitrage bots.
1inch was born as a crypto exchange that aggregates token prices from other decentralized exchanges, giving users access to the best token-swap prices without needing to manually check every exchange and manually commit trades.
1inch Launch and Funding
After the ETHGlobal hackathon, Kunz and Bukov raised $2.8M funding round through Binance Labs, Galaxy Digital, FTX, and other investors. The 1inch network went live in August 2020.
Later that year, the venture launched the 1INCH governance and utility token allocated to the network’s treasury via decentralized autonomous organization (DAO).
Then 1inch launched Mooniswap, the network’s own automated market maker (AMM) underpinning its order-matching system.
How Does 1inch Work?
The concept of data aggregation is not new. Long before Bitcoin popularized blockchain networks, aggregator websites were popular. Whether it is about hotel booking prices, computer components, smartphones, or kitchen appliances, these websites would scrounge price data from other sites and gather them on a single platform.
Then, users could filter the results for a given product from low to high and vice versa. 1inch does the same job, but for cryptocurrency/token prices. It gets the prices from other DEXs like Uniswap, 0x, Bancor, or Kyber. In charge of the price aggregation is 1inch’s Pathfinder protocol.
Pathfinder Aggregation Protocol
Pathfinder is an algorithm that seeks out best trading opportunities across multiple ecosystems. Moreover, it takes into account the cost of fees for each token-swapping pair. Once identified, Pathfinder then breaks single trades into multiple parts across different platforms, arriving at the optimal trading solution.
If one were to exchange Wrapped Bitcoin for DAI, for example, 1inch’s Pathfinder may find it is cost-efficient to first convert wBTC into another stablecoin on one platform and then convert that stablecoin into DAI.
As this complex process unfolds, 1inch dApp users simply see the end result, not bothered by either price discovery or the convoluted breaking down of trades to arrive at the optimal price.
1nch Liquidity (Former Mooniswap) and Limit Order Protocols
The underpinning of any DEX is its liquidity collection. On CEXs like Binance, the company would be in charge of providing liquidity thanks to traditional banks. On a DEX, users themselves provide liquidity, which is why they are called liquidity providers (LPs).
Investors deposit crypto funds into smart contracts for a given token pair (USDC/ETH). These smart contracts are liquidity pools, serving as a repository for token swapping. Then, when a trader taps into one of the liquidity pools, filled by LPs, they pay a small fee, given to LPs for their service.
In charge of matching these trade orders and generating passive income through fees are AMMs. 1inch has its own take on AMMs with Mooniswap, rebranded since v2 to a more mundane 1inch Liquidity Protocol.
It is important to understand that the downside of DEXs and AMMs is that they generate slippage. This happens when there is not enough liquidity provided, so the price of the asset is higher than originally requested.
Here is a brief illustration of slippage:
- Adrian wants to buy $10,000 worth of ETH, at $1,500 per ETH.
- The DEX’s liquidity pool holds only $6,000 worth of ETH.
- Because there is not enough ETH at that price point, the AMM matches to an order at a higher ETH price point (slippage percentages vary from one DEX to the other).
- Therefore, Adrian would pay more for each ETH than he would have on a CEX.
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1inch’s Liquidity Protocol connects to over 21 DEXs to deepen its liquidity pools and neutralize slippages for individual trades. In addition to this, 1inch also deployed virtual rates to deal with front-running by bots.
This is a malicious activity when traders deploy bots to bid higher fees for transactions, so their own are put before the pending ones. 1inch’s virtual rates adjust liquidity pool fees, making front running too costly to execute.
Speaking of fees, 1inch protocol itself doesn’t charge fees. Instead, traders are only charged exchange fees (for LPs) and gas fees for the given blockchain network.
Lastly, with a Limit Order protocol, 1inch traders can customize their orders to prevent losses. These are typically trailing stop orders and stop-loss orders, designed to automatically lock-in profits by setting exchange rate ranges.
1inch Governance Through 1INCH Token
As other DEXs, 1inch has its own governance token 1INCH. It doesn’t have a maximum supply, but it has a total supply of 1.5B 1INCH, out of which 38% is in circulation. 1INCH token holders have voting rights that facilitate the network’s instant governance.
Through 1inch DAO, anyone holding 1INCH tokens can participate in 1inch development. Specifically, how the aggregator finds and adds DEXs, DAO treasury management, determines API rates, liquidity pooling, etc. 1INCH tokens were retroactively distributed on Christmas in 2020. The first airdrop dished out 6% out of 1.5B 1INCH, after which 14.5% is scheduled to be unlocked for the following four years.
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For the protocol’s funding and community incentives, 23% of 1INCH tokens was reserved. In addition to 1INCH, there is also Chi Gastoken, a specialized token used for gas fees. Simply put, Chi Gastoken is a pegged and tokenized version of ETH gas fees, just like the USDC is a tokenized version of the dollar.
When users vote, they stake their 1INCH tokens, after which they receive a 100% gas refund.
At its highest price point, 1INCH reached $7.87 in May 2021, having gone down over one thousand times since. 1NCH token is available on all major exchanges. Interestingly, the DEX aggregator has its own 1inch wallet that not only allows token swapping and governance staking, but retro gaming as well.
Which Blockchain Networks Does 1inch Support?
As you might have guessed from the ETHGlobal hackathon origin, 1inch originally launched on the Ethereum blockchain. Since then, it has spread out its aggregator wings to multiple Ethereum scalability networks and competitive blockchains:
- Optimism (L2)
- Polygon (L2)
- Arbitrum (L2)
- BNB Chain
Nonetheless, not all of those networks employ all 1inch features (liquidity, limit order, governance, and aggregation). Networks that employ all four 1inch features are only Ethereum mainnet and BNB chain.
To connect to other networks, one must switch the wallet’s network, such as MetaMask, and then select the network within the 1inch dApp itself.
This series article is intended for general guidance and information purposes only for beginners participating in cryptocurrencies and DeFi. The contents of this article are not to be construed as legal, business, investment, or tax advice. You should consult with your advisors for all legal, business, investment, and tax implications and advice. The Defiant is not responsible for any lost funds. Please use your best judgment and practice due diligence before interacting with smart contracts.