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The Evolving DEX market – Uniswap & DeFi

First, some context around exchange evolution through the crypto age..In the recent past, essentially post 2016, Ethereum’s smart contracting functionalities and openness have fuelled the rise of decentralized exchanges (DEXs), which are crypto-native alternatives to vulnerable, insecure, rent-seeking centralized exchanges. Prior to Ethereum’s launch, almost all crypto trading had been exclusively limited to centralized exchanges, which are less transparent, are honeypots perpetually besieged by hackers, given that they retain full custody of users’ funds. For lack of a better alternative, and also perhaps blinded by the bullish crypto-market-on-red-bull, crypto traders had to put up with issues such as loss of private keys, unexpected shutdowns, CEOs passing away, etc. Thus, obviously, when the alternative finally arrived in the form of the first iteration of DEXs, DEXs were expected to make a big dent in the market share of centralized exchanges, with traders expected to defect to DEXs en masse for the reasons stated above.

However, these predictions were quickly proven wrong as DEXs had to contend with their own set of problems – UI/UX, trading costs, lack of liquidity, as well as limited functionality set compared to centralized exchanges. In fact, trading experience on early DEXs were fairly cumbersome and expensive, and traders, despite their misgivings about centralized exchanges continued to trade on the latter. As DEX projects and platforms like 0x and Kyber have iterated based upon user feedback, some of the issues vexing DEXs, such as the thin liquidity and the high latency, are slowly being addressed. One DeFi apps called “Uniswap” has recently seen significant traction with DEX users.

Uniswap has come up with a unique solution to address the liquidity problem that is grappling most DEXs right now. Up until now, the traditional way of solving the “chicken and egg” problem of liquidity of exchanges (both centralized and decentralized) is through incentivizing ‘designated’ professional market makers to provide liquidity in return for trading fees rebates, revenue sharing agreements or a combination both. Market makers could also earn additional income through arbitraging and placing orders to benefit from their bets on markets’ direction. Owing to the trading nous and high capital investment required in the market making business, providers of liquidity usually are specialized entities that employ sophisticated traders. The bar is just way too high for retail investors to act as liquidity providers. Moreover, market makers prefer centralized exchanges to decentralized exchanges, partly because decentralized exchanges require a fair bit of technical acumen to trade on them (interfacing with Metamask) and they are slower and offer limited features (basic limit and market orders). This is where Uniswap’s ingenuity comes to the fore. Their solution abstracts out the complexities of order books and price determination, and incentivize retail users, including HOLDers to pool in liquidity for a share of the trading fees in return. With a single click of a button, retail users can create liquidity pools or add more to the existing ones. Liquidity providers get newly minted liquidity tokens that can be used to redeem contribution to the pool. As the price for every trade is determined algorithmically, retail investors pooling liquidity can forget about the price at which they want to buy/sell their assets. And Uniswap works in such way that no matter in which direction the market moves, the value of your share of the liquidity pool is worth less than what your initial contribution was. The loss in value of your share of liquidity pool is compensated for in the form of trading fees entitlements that is proportional to your share of the liquidity pool. This is essentially the only way to gain equity-like exposure to Uniswap. As trading volumes and therefore trading fees increase, you stand a chance of earning in excess of the losses of your liquidity pool due to market movements. In essence, for the market-maker, it is a short-vol trade, with the losses increasing if prices either increase or decrease significantly. Uniswap is emerging to be a key piece of the emerging DeFiecosystem.

We plan to deconstruct Uniswap’s working model and how market makers will actually make money in one of our future posts.

Meanwhile in Crypto Wonderland….

“Fidelity Invests in Coinmetrics” Coin Metrics, a cryptocurrency data provider firm, announced recently that it raised a whopping $1.9 million through investments from various institutions, which included Fidelity Investments, Castle Island Ventures, Highland Capital Partners and Dragonfly Capital. They originally founded the company in 2017 as an open source blockchain data and analytics project to help equip people and investors with the required data and tools related to crypto assets. Originally the company was funded by donations and sponsors, but it changed after they brought in Tim Rice, launching the company to institutional investors in the cryptocurrencies.

“$320 Million in DeFi” Close to $320 million eth is currently locked in various smart contracts that provide numerous functions like collateralized crypto lending, decentralized betting, or more scalable crypto payment systems. According to a new stats website, MakerDAO’s DAI dominates by far with some $288 million worth of ETH currently locked in their smart contracts. Compound seems to have made a comeback, with $23 million eth stored there. They’re kind of similar to DAI, but instead of collateralizing for a stablecoin, you collateralize eth for another token or indeed tokens for eth.

“Crypto Regulation in Europe” Steven Maijoor, who chairs the European Securities and Markets Authority (ESMA), has shown support for further regulation of crypto assets. Maijoor said he would like to see financial instrument regulation applied to cryptocurrencies in line with Europe’s securities laws, ostensibly to “help protect investors.” Maijoor also backed the broadening of Europe’s anti-money laundering rules to include the exchange of one digital asset for another, and not only the exchange between cryptocurrency to fiat money.

“Putin’s Deadline for Cryptocurrency Regulations in Russia”Kremlin.ru, the official website for the President, issued a document which instructed the Federal Assembly, the national legislature of the Russian Federation that cryptocurrency regulations should be issued latest by July 1, 2019. The main aim of the regulations, according to the document released, is to creating a developing regulatory environment so that the country’s digital economy can improve. The regulations are not meant to govern an isolated part of the industry, but rather to push the entire economy upwards. Furthermore, these regulations will include civil-law digital settlements, and in addition to cryptocurrencies, the guidelines will also encompass digital financial assets.

Crypto Twitter Pick

What We’re Reading / Listening To

Busting Myths About Cryptocurrency Custody by Brian Armstrong

Web3 Summit Governance Panel with Vlad Zamfir, Gavin Wood, Arthur Breitman & Adrian Brink


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