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Revisiting Centralized v Decentralized Exchanges

While most cryptocurrencies have enjoyed strong returns in 2019 so far, one particular category of tokens that has had a great year is centralized exchange tokens.

Native tokens of leading crypto exchanges such as Binance and Huobi have outperformed BTC significantly, posting 366% and 343% respectively in YTD returns. Contrasting those numbers with those of DEX tokens highlights the plight of DEXs currently. In a year where almost virtually every cryptocurrency has yielded positive returns, leading DEX tokens such as 0x and Bancor have posted negative returns YTD. 

It is quite puzzling and also quite obvious at the same time. First the puzzling bit; In the wake of all the centralized exchange hacks, it was assumed that trustless, peer-to-peer exchanges with self-custody would see significant traction. Moreover with DEXs, the KYC/AML bars were also assumed to be lower. See our coverage on DEXs here and here.

However, that is not quite how this has turned out. Centralized exchanges are doing more than just matching orders by incentivizing users to hoard exchange tokens by offering rebates on trading fees and eligibility to participate in IEOs. And the bull run in 2019 that saw a surge in trading volume aided centralized exchanges even more. On the other hand, DEX tokens are still struggling to come up with unique incentive structures for users to use DEX tokens. Decentralized platforms’ efforts to provide non-custodial trading interface for users is well-intentioned, but technical challenges pertaining to speed and UI/UX remain, resulting in trivial trading volumes.

The gulf between centralized exchanges and decentralized exchanges seems to be widening and we expect this trend to continue for a while in the near term. Even Binance recently launched a DEX to cover that flank, and also added some typically jazzy marketing involving tokens for good measure. FATF regulations from the latest G-20 guidelines also seem to suggest that any DEX operator that faciliates trades through their venue is liable for making sure that all is kosher with participants on the venue, i.e, KYC/AML requirements will be required.

Perhaps users ultimately still prefer convenience over decentralization;especially with the UI and the speed advantages that centralized exchanges have over their DEX counterparts.

However, we remain bullish on the long-term future of DEXs. DEXs capture the true power of blockchains and smart contracting. Centralized Exchanges are not ‘crypto-native’, they are a traditional market construct that has been force fitted into the blockchain paradigm.  DEXs are completely trustless, peer-to-peer and have modularization that lets platform developers separate the platform from the regulatory aspects such as fiat on-off ramps and KYC/AML filters. In an era of rampant hacks and assaults on privacy, DEXs provide an element of true anonymity, much like SSL (Secure Socket Layers) did in the early days of the internet, truly kicking off e-commerce and transactions on the internet. UI is already improving, with metamask launching a mobile wallet soon, and 0x for instance has announced a slew of upgrades including a liquidity reward for market makers and governance feature through staking ZRX tokens.

DEXs will allow for the use of smart contracts to programmatically bring together multiple facets of decentralization that define the new era of distributed finance (DeFi), such as lending and borrowing, leveraging, automated credit assessment (Dharma, Compound, DyDx, Bloom, SALT, ETHLend, etc). We eagerly await the next iteration of current (and emerging) DEX protocols.

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What We’re Reading / Listening To

Ethereum: The Digital Finance Stack by David Hoffma
nFrom The Housing Bubble to Bitcoin with Kyle Bass

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