Kyber Network is an Ethereum-based, decentralized liquidity network and payment service for the instant conversion of digital assets. Although the protocol presently only deals with Ethereum-based ERC20 tokens, the project's goal is to make all blockchain-based tokens exchangeable, including security tokens that represent ownership of tradable financial assets.
The network has recently announced several updates. These and ongoing partnerships may make the network increasingly more liquid while allowing users to trade real-world value (e.g., tokenized real estate assets) for goods, services, or other tokenized assets. In this article we'll explore the basic workings of Kyber Network, recent and upcoming developments, and how Kyber differs from standard decentralized exchanges.
How Kyber Network Works
Kyber rewards a class of users called "reserve contributors" for pooling different exchangeable tokens in a reserve smart contract to earn passive income. In doing so, Kyber Network allows both individual users and merchants to quickly swap between a growing list of tokens. This allows users to manually trade one token for another at very close to market rate (one analysis put the price for tokens at within 1.5 percent of the price of popular centralized exchanges), while also allowing merchants to automatically accept payment in any supported token.
Kyber Network launched earlier this year and currently supports more than 60 tokens, including ETH and BAT, as well as stablecoins DAI, TUSD, and DGX. This means that merchants can receive cryptocurrency payments that automatically lock in the value of their payments. That could be important if/when cryptocurrencies catch on as a more universal payment method.
Instead of using an order book like most exchanges, Kyber Network utilizes a "reserve warehouse" for each of its supported tokens, maintaining a contributor-supplied reserve of tokens that are ready to be swapped with other tokens.
As an example, when a user requests a conversion from Token A to Token B, the Kyber smart contract checks that Token A has been credited to the contract (including a fee), looks for the best price from any reserves holding Token B, then sends the correct amount of Token B from the chosen reserve to the sender's address; at the same time, Token A + fees are sent to the Token B reserve address.
Since all of this happens automatically on the blockchain, this can be considered an "atomic swap," effectively creating an instant, trust-less exchange between parties.
Kyber Network Roles
To understand how Kyber's protocol works in more detail, we can look at the five roles, or different types of actors, that allow the network to operate.
- Users are any entities sending or receiving tokens, including individuals, smart contract accounts, and merchants. Each transaction costs the sender about 0.01 percent on top of Ethereum's gas fees.
- Reserve entities (public or private) provide liquidity to the platform by storing tokens that are exchanged on the network. This includes the network's built-in reserve, as well as third-party reserves already operating. Taken together, all reserve entities make up the dynamic reserve pool. This network of third-party entities is intended to prevent monopolization and keep exchange prices competitive, since the reserve entity with the best rate is always chosen for an exchange. Different reserve entities may also add different tokens, expanding the number of tokens available for exchange. To curtail bad actors in the pool, Kyber Network has safeguards such as a flagging system for entities well outside of normal exchange rates, and a transparent fund management model for all public reserves.
- Reserve contributors are simply users who fund public reserve entities and share the platform's profits.
- Reserve managers maintain their reserves, setting exchange rates for their reserve(s), and sharing profits with contributors on the spreads they set for their reserves.
- The Kyber Network operator is responsible for adding and removing reserve entities and listing or delisting exchange pairs. To begin with, the Kyber project's team acts as the operator, but a decentralized governance entity is set to replace this function at an undermined date.
Recent Developments and Next Steps
Since its launch, Kyber has partnered with various wallets, online games, decentralized exchanges (DEXs), and financial applications, which have begun to use Kyber Network for liquidity, atomic swaps, and payments. These include OasisDEX, Peepeth, ETHIS, Etheremon, Secrypto, KCash, Midas Protocol Wallet, Weswap, and bZx. Kyber Network has also partnered with decentralized hedge funds, including Melonport, which will allow people to invest in trust-less hedge funds to earn a share of profits from pooled investment vehicles.
The team is currently focused on phase 3 of development, which includes working on support for trading "advanced financial instruments," including derivatives in the form of forwards and options contracts.
A forward contract is a contract between two parties to buy or sell an asset at a specified price on a future date. Using Kyber Network, one party could essentially bet that the price of a token will go up, thus locking in a lower price to buy that token at a later date from another party who thinks the value will go down.
Options contracts on Kyber Network are contracts that will allow users to hedge against price movement of a token for a fee called a premium. Although details are limited on how this will work, in a securities market, call options are contracts that give the holder the right to buy an asset at a specified price, for a specified period of time. Investors buy calls when they think an asset's price will rise. A put option allows a user to sell at a specified price. It would be bought if the investor thinks the asset's price will fall. The premium fee on Kyber Network will be calculated using some sort of volatility measurement for the underlying assets.
As mentioned, Kyber Network currently only works with ERC20 tokens on Ethereum's blockchain, but the project has plans to expand to other blockchains starting with Bitcoin and the zkSNARKS-based privacy coin Zcash. To do this, the team is exploring either using chain relays (e.g., BTCRelay and ZecRelay) or interchain communication protocols (e.g., Cosmos and Polkadot).
Finally, another future concern of the project is scalability (the ability for many more users to use the platform at once). Although details are still scarce, the team intends to implement a type of network sharding (breaking the network up into pieces to perform transactions faster) they're calling Gormos on top of Ethereum's Plasma framework.
How It Compares To Decentralized Exchanges
Kyber doesn't refer to itself as a decentralized exchange, but it shares some functions. One popular competitor is the 0x project. The main difference between the two is that Kyber uses on-chain exchange processes, whereas 0x has its order book off-chain, using intermediaries to handle matchmaking.
Another "decentralized exchange" is IDEX, which might be more aptly called a "non-custodial exchange" since the only decentralized aspect of IDEX is the deposit/withdrawal of funds. Although hacking IDEX and stealing funds is all but impossible (each user holds their funds in their own wallet) trading on IDEX is still centralized. All orders first go through IDEX's centralized servers before being recorded on the blockchain, whereas Kyber Network uses an on-chain exchange.
Finally, Bancor works in a similar manner to Kyber in that a user receives an exchange quote, sends Token A to a smart contract, and receives Token B back. However, Bancor's method for providing liquidity is different. Whereas Kyber relies on reserve managers (which could be seen as at least a minor form of centralization), Bancor uses EDCCs (aka smart contracts) to create a fully decentralized reserve. They do this through creating "smart token" smart contracts for every trading pair, holding a reserve for each token, and setting the rate based on how many tokens are in the reserve. The plus side to this is that it is arguably more decentralized, but the downside is that token prices may go up more easily, making for less liquidity.
Kyber Network has already attracted a lot of attention as a platform for quickly and easily swapping tokens at close to market rates with a simple interface. If successful, upcoming tools such as derivatives trading and cross-chain trades may boost the usefulness of the platform as a cross-chain investment and payment liquidity solution.