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As venture capital shifts focus from DeFi to AI, the decentralized protocol DFlow has caught investor interest. On Tuesday, DFlow raised $5.5 million on the promise to build and expand a decentralized order flow marketplace.
Having previously raised $2 million in March 2022, the latest funding round was also led by Framework Ventures, additionally boosted by Circle Ventures, Coinbase Ventures, Spartan Group, ZeePrime, and Wintermute.
Untypically based in Nicaragua instead of California, the DFlow team launched the project at the start of 2022.
Why is PFOF Controversial?
In stock trading, payment for order flow (PFOF) has become synonymous with moral hazards. Because stock brokers, such as Robinhood, receive a fee for directing orders to a specific market maker, such as Citadel Securities, they are incentivized to prioritize this pathway over others.
In turn, this may not be in the customers’ best interest, even resulting in subpar trade execution prices. That is ingrained in the PFOF cake because market makers would be incentivized to offer worse execution prices to compensate for paying for order flows.
But on the other hand, brokers could market their service as commission-free to customers. This psychologically unburdens retail investors, who are more likely to be put off by paying commissions on trades.
What Does DFlow Bring to the DeFi Table?
DFlow aims to remove the moral hazard from PFOF by making it transparent and fair. The protocol uses order flow auctions (OFAs) to make it happen. Through them, DeFi participants, such as wallets and Web3 exchange dApps, could monetize their buy/sell orders without compromising settlement prices.
For instance, order flow sources like wallets can route orders to OFAs, hosted by DFlow built by Cosmos SDK. In exchange, market makers would give wallets a cut (in USDC stablecoin) as they bid on DFlow’s OFAs to execute trades.
On the customers’ end, through OFA’s bidding process, they would get their trades executed at the best available prices. DFlow would algorithmically ensure that these prices are better than the Consolidated Best Price (CBP) set by decentralized price-feeding oracles like Chainlink. In the end, customers can receive the best price out of both decentralized and centralized exchanges.
Because these orders and executions are blockchain-based and automated by smart contracts, they could then be verified by all parties. This starkly contrasts with the obfuscation in stock trading via dark pools.
Is Decentralized PFOF the Next DeFi Frontier?
DFlow founder Nitesh Nath is no stranger to financial markets. Having previously worked for Chicago-based quant trading firm DRW, Nath sees an opening left wide by a less-than-transparent legacy system.
“If you look at equities markets, retail investors don’t trade directly on the NYSE, they trade on Robinhood against market makers, who may hedge on NYSE,”
If DFlow gains traction, it may be enough to push DeFi into the mainstream. Despite employing the somewhat tainted PFOF model, it is merely an incentivization scheme. And if that scheme is transparent, with all order execution statistics available, it is self-regulating.
As the Securities and Exchange Commission (SEC) still mulls over the rules to overhaul retail investing, blockchain technology has found a way to make the process robust without centralized oversight.
Do you think DFlow will reshape the PFOF landscape? Let us know in the comments below.