Understand CowSwap in Three Minutes: How to Achieve No MEV and Low Fee Transactions?

This article is from Chain News, authored by Leo Young.

Ethereum not only suffers from high user transaction fees due to performance issues, but MEV (Miner Extractable Value) also deters many users.

At the beginning of this month, the Gnosis Protocol announced the launch of the second version GPv2, which integrates decentralized exchange liquidity and can provide MEV protection. CowSwap is a decentralized trading application based on GPv2 that is worth paying attention to.

It is important to note that CowSwap is developed by the Gnosis Protocol development team. Gnosis is a decentralized application infrastructure with products including decentralized prediction markets, multi-signature wallet Gnosis Safe, Gnosis DAO, auction markets, and various other types of applications, with the native token of the protocol being GNO.

What are the features of CowSwap?

The name CowSwap seems related to "cow," but in fact, "Cow" refers to a unique trading matching method of the product. The product documentation states that CowSwap uses a "Coincidence of Wants (CoW)" method to match trades.

Specifically, "Coincidence of Wants" is an economic phenomenon where "two people simultaneously hold things that each other needs, allowing them to trade directly without using money as a medium."

In traditional trading markets, liquidity is provided by market makers, while current decentralized exchanges (DEX) are mostly provided by liquidity providers. CowSwap matches CoW orders for traders through a batch auction mechanism as its core trading mechanism.

In other words, if two people on CowSwap simultaneously hold assets that they want from each other, they can directly match trades without the need for market makers or liquidity providers to facilitate the transaction. This not only brings the best price to individual traders but also eliminates the fees incurred through market makers or liquidity providers.

CowSwap allows users to trade directly using the CoW method. Orders that cannot be settled through CoW will be matched through an Automated Market Maker (AMM).

If there are CoW orders in the batch auction, after fully matching small orders, the remaining orders that were not matched through CoW will be matched by the liquidity market integrated by CowSwap. The settlement price of the entire order will be based on the price of the remaining orders obtained from external liquidity.

Currently, CowSwap integrates with Uniswap and will later integrate with Balancer and more DEX liquidity.

What are the advantages of CoW?

According to the project team, CoW matching has two advantages: avoiding MEV and reducing trading friction.

Since CoW does not require external on-chain liquidity and settles at a uniform price within batch orders, all order prices are consistent, eliminating the issue of transaction ordering and fundamentally avoiding MEV situations.

For trades matched through external on-chain liquidity, GPv2 introduces the concept of "solvers." "Solvers" are third-party tools introduced within the protocol that compete to find the best on-chain trades, matching trades off-chain and batch publishing them.

Due to strict limits on the slippage of trades executed by "solvers" within the protocol, the profit margin for MEV arbitrage is minimal. Moreover, batch order settlements can only be submitted by certified solvers, significantly reducing the operational space for miners and MEV arbitrageurs.

Since CoW does not require third-party liquidity, CoW trades have no trading costs. However, trades on CowSwap will incur a certain fee. The fee consists of the base cost of executing the order and protocol fees. A portion of this is paid to solvers as an incentive to provide the best trades within the protocol. Currently, users only need to pay gas fees (base transaction fees), and protocol fees are not charged at this time.

CowSwap currently only supports market buy and sell orders. In CowSwap, trading requires only one off-chain signature. Users only need to sign and submit the trade, and solvers will match the trade. Fees are only required when the order is executed; failed trades incur no fees.

Conclusion

Current DEX aggregators rely entirely on third-party liquidity, which can reduce slippage and improve trading efficiency, but still incur trading costs. CowSwap combines CoW orders with third-party liquidity, retaining the aforementioned advantages while also reducing trading fees.

In the future, CowSwap is expected to incentivize CoW trading depth and introduce CoW market making. Market makers will monitor limit orders within the protocol, provide counter trades, and reduce reliance on third-party liquidity. This fundamentally eliminates MEV and reduces fees, providing users with an optimal experience.

It is also important to note that CowSwap has not issued a token, and the Cowswap tokens on the market are not tokens within this protocol.