What is 0x (ZRX)? The Framework for Building Crypto Exchanges Explained

A crypto exchange can be a lucrative business, especially when the market is active and trade volume — the total value of transactions — is sky-high. However, building an exchange from scratch is challenging because you need some level of liquidity, crypto assets that are kept in the exchange’s balance.

Without liquidity, any user of that small exchange will experience extremely volatile prices whereas that won’t happen on bigger exchanges with deeper liquidity. 0x (pronounced “zero-X”) attempts to solve this problem using some clever transaction routing mechanisms to give traders the best prices possible.

Takeaways

• The 0x protocol was designed to serve as an open standard and function like building blocks for developers who need exchange functionality.
• 0x facilitates peer-to-peer exchanges of Ethereum-based assets, such as ERC20 tokens.
• ZRX is 0x’s native token that is used for governance in how the protocol evolves in the future, and also for staking rewards to earn ETH.
• The 0x protocol is a large contributor to Ethereum’s rapid growth in the DeFi space, facilitating developers and communities to innovate new ways of making use of blockchain technology.

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What is 0x (ZRX)?

0x is not an exchange, but a framework for building exchanges. It’s essentially a build kit that developers can use to build an exchange. 

Developers can focus on the user experience on the front-end. The smart routing, transaction settlement, and liquidity aggregation are all technical processes that the developers don’t have to worry about. That’s because 0x does that for them, out of the box. 

0x has been around for a long time. Built in 2016, 0x has helped countless developers to launch crypto exchanges. At some point, you may have used a crypto exchange or NFT marketplace that uses 0x behind the scenes. This is how popular it has become. 

Here are some examples of things that can be built using 0x:

• A decentralised market for any token, whether it’s as famous as Bitcoin or some meme-coin forked from another meme-coin.
• A marketplace for digital collectibles (NFT).
• A trading bot that buys a token cheaply at one market, and sells it in another market.
• A human-centric trading desk for over-the-counter (OTC) trades.

0x is built on top of Ethereum, the most popular smart-contract blockchain, on top of which numerous crypto exchanges have been built. Naturally, 0x supports all of the Ethereum token standards, from ERC-20 to ERC-721 and ERC-1155 for NFTs.

What problems is 0x (ZRX) trying to solve?

As prefaced, liquidity is a problem for small exchanges. Here’s a short explanation on why liquidity is a deal-breaker for exchanges.

Traditional exchanges use order books

Traditional markets facilitate trades by collecting all the buy and sell orders into one centralised book. When a trader orders to buy, the facilitator takes the buyer’s money and will only execute a trade at a certain price. 

The same thing occurs when a trader orders to sell — the facilitator takes the seller’s asset in preparation for the trade. When the buy and sell prices match, the facilitator finds a matching trade, which then gets executed.

This works well on centralised, traditional exchanges. The facilitator must temporarily take the buyers’ and sellers’ cash and assets before the trade can take place. But on decentralised exchanges, this process can become costly to the network. 

If traders have to send their tokens to a smart contract before they find a matching trade, the traders have to pay twice. First, to send Token A to a facilitator smart contract, then to receive Token B from the facilitator smart contract. 

The double transactions will double the traffic on Ethereum, causing congestion and pushing up transaction fees (gas fees).

Decentralised exchanges use liquidity pools

The solution for decentralised exchanges is to use what’s called a liquidity pool. In this system, traders don’t trade with each other. Instead, they trade with a smart contract that mathematically determines a fair price based on trading activity.

A liquidity pool is filled with a specific token. Each liquidity pool is filled in proportion to other pools, depending on their relative prices. If someone were to trade USDC for ETH, the USDC pool would increase in volume, while the ETH pool would decrease in volume.

A mathematical equation determines the change in the price of ETH relative to USDC after checking the volume change of each of the pools. The prices will continue to fluctuate due to the volume change of liquidity pools in that exchange.

What if the exchange has very low liquidity to begin with?

With low liquidity, traders will experience volatility and prices will not even be remotely close to the global average price. This is assuming that the exchange is isolated from any other exchanges or liquidity providers.

The reason for this volatility is that a large trade can dramatically change the size of the pool relative to other pools. Imagine throwing a rock into a lake versus a pond — you’ll greatly disturb the water in the pond than that in the lake.

0x connects exchanges and liquidity providers with each other

Exchanges that use 0x technologies will, in some sense, share liquidity. Instead of having a collection of isolated liquidity pools where asset prices are very different from one another, 0x makes asset prices as fair as possible across different exchanges.

How to use 0x (ZRX) tokens?

Governance

0x is an open-source software that must be maintained and upgraded with passing time. However, unlike traditional open-source software, there isn’t a single company that has a complete control of all of 0x’s code. 

Instead, a community of developers can get together to discuss changes to the 0x software. The 0x token is central to this democratic process. 0x tokens are used to make improvement proposals and cast votes. The voters have a various degree of voting weight, depending on the amount of 0x at stake. 

0x is also paid to developers who sought grants for executing the improvement proposal — if the votes agree to the improvement proposal, of course.

Staking

Staking in the context of 0x is different from, for example, Ethereum staking. When 0x is staked, it’s placed in various liquidity pools, among which is Matcha, 0x’s proprietary liquidity aggregator or exchange. 

When 0x becomes more available for trading, it sort of adds value to 0x. A valuable token is necessary for governance and protecting the future of 0x.

Stakers also earn passive income from staking 0x. The additional value for passive income is tied to lending 0x to liquidity pools. This is valuable because it allows new exchanges to get up and running quickly without needing a huge starting capital. 

0x (ZRX) tokenomics and history

The total supply of ZRX tokens is 1,000,000,000, which was issued at once in 2017 and sold through a public token selling event called an initial coin offering (ICO). This is similar to initial public offerings (IPO) for companies who turned their equity shares into securities.

Whether ZRX is a security or commodity is up for debate, but the team behind 0x had raised $24 million as a result of this ICO. Until today, ZRX is an ERC-20 token, much like other tokens for applications that are built on top of Ethereum.

0x was founded in 2016 by developers Will Warren and Amir Bandeali. Warren has a degree in mechanical engineering at UC San Diego, and was a technical advisor for the Basic Attention Token (BAT) project before collaborating with Bandeali. Bandeali earned a degree in finance at the University of Illinois, and worked at Chopper Trading before 0x.

After the ICO, 0x also completed 9 funding rounds to raise a total of $109 million, led by Polychain Capital, Pantera Capital, Blockchain Capital, to name a few.

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The takeaways

0x is a software framework for building exchanges. Developers can focus on the user experience on the front-end, while the smart transaction routing, settlement, and liquidity aggregation are all done by 0x.

0x makes asset prices as fair as possible across different exchanges. Instead of having a collection of isolated liquidity pools where asset prices are very different from one another, 0x aggregates liquidity from different exchanges across the world.

The 0x token ZRX is used for governance and staking, which also helps new exchanges get started quickly without requiring large amounts of liquidity and capital.

Further reading: Explore more topics on all things crypto in our learning hub.