DEXs Gain Market Share as Faith in Centralized Crypto Players Erodes

What happened

The collapse of FTX Trading and related solvency issues on other centralized crypto exchange and lending platforms are giving a boost in market share to peer-to-peer competitors. Trading volume on decentralized exchanges (DEXs) already reached $91 billion in November, a 79% increase over the entire month of October. DEXs are gaining ground on their centralized competitors, with spot trading volume today at 16.7% versus 10.8% in September.

Uniswap is the leading DEX in terms of trading volume and number of users. Founder Hayden Adams recently tweeted that Uniswap overtook Coinbase in daily volume for the Ether/US Dollar trading pair (~$1.1B vs. ~$600M).

DEX aggregators have also seen an increase in usage. Aggregators allow traders to scour the entire DEX landscape to find the best prices and lowest fees for a particular trade, routing orders to be filled on the exchange offering the best deal. Some of the biggest aggregators are 1inch, DODO, Kyber Network, Matcha, and Paraswap.

As the FTX drama unfolded, daily DEX volume on the Ethereum blockchain jumped 640% to $573 million on November 10 from $77 million a few days earlier.

Broader context

Since DEXs use decentralized smart contracts encoded on public blockchains, users always retain the private keys to their crypto wallets, removing the counterparty risk inherent in centralized exchanges (CEX). Users never need to relinquish control of their assets while enjoying decentralized commerce and other financial services.

This stands in stark contrast to the centralized infrastructure that grew to serve the first cohort of crypto users. CEXs allow users to trade various crypto assets or transfer conventional currency holdings into the crypto economy, but users must first deposit the assets on these platforms to access liquidity.

In the case of FTX, the centralized exchange apparently did not maintain individual reserves of user deposits, as it should have. Instead, he appears to have misappropriated the assets in a number of ways, including loaning them to FTX executives for personal use and its hedge fund sister company Alameda Research, as well as using the funds to bail out others. centralized crypto firms at risk. , such as BlockFi and Voyager.

Additionally, FTX had launched its own DEX on the Solana blockchain called Serum. Serum has a different architecture than other DEXs, with an on-chain central limit order book (CLOB) rather than an automated market maker (AMM) employed by Uniswap. The SRM token had a low float (circulating supply of only 3%) and a large percentage of its supply was held by FTX and Alameda. This contributed to its price crashing 70% during the FTX fallout.

Many DEXs have their own tokens that offer governance rights, the ability to vote on improvement proposals, or the use of funds raised in the community treasury, or have a mechanism for accumulating value in the form of a claim to a percentage of revenue generated by the protocol. For example, Uniswap’s UNI token offers governance rights while Curve’s CRV and Sushiswap’s SUSHI offer both governance rights and a claim on trading fees when staking the token.

Since the FTX news started breaking in early November, prices for DEX UNI, CRV, and SUSHI tokens have fallen by 18%, 33%, and 25%, respectively. During the same period, Coinbase’s stock price fell 24% and recently hit a new all-time low of $40. Although Coinbase is a public company and a regulated entity in the United States with much better risk controls and practices in place than offshore exchanges, the market has punished all crypto players, centralized and decentralized.

Key stat

Uniswap has the largest market share among DEXs in terms of trading volume, with 60%, or $6.7 billion, in the last seven days. It is followed by Curve ($2.4 billion), DODO ($1.1 billion), Balancer ($414 million) and Sushiswap ($219 million).

Prospects and implications

The ethos of the crypto industry has been to allow users to use decentralized technology to protect themselves from the actions of risk-seeking intermediaries. The irony of recent weeks is that the damaging actions of fraudulent and opportunistic centralized actors within the crypto industry have highlighted the need for decentralized applications. The activities of FTX, Celsius, BlockFi, Voyager and other seemingly dishonest players have led to results that the technology was meant to prevent.

While centralized enterprises imploded, decentralized applications and major encryption protocols worked exactly as intended. Decentralized finance (DeFi) applications worked smoothly, and the Bitcoin and Ethereum networks processed transactions without a hitch. In order to avoid meltdowns and loss of customer funds in the future, the answer is to lean into DeFi and make it easier for users to retain custody of their own assets and interact with decentralized applications.

Although trading volume has increased for market-leading DEXs, their interfaces are still difficult to navigate and their users are confined to a relatively small base of sophisticated traders and investors. In order to truly realize the potential of self-custodial trading services and other DeFi applications, projects need to develop more user-friendly transfer and custody mechanisms.

Centralized exchanges currently dominate in terms of number of users and trading volume. To date, Uniswap has a total of approximately 4.5 million cumulative users. As of its last quarterly filing, Coinbase had a total verified user base of 108 million, or about 24 times that. We could start to see these numbers converge and possibly shift as users learn about the benefits of DEXs and the risks of engaging with centralized vendors.

Decision Points

Surprising as it may seem in terms of scale and possible contagion, FTX is only the latest centralized exchange to be embroiled in corrupt business practices leading to insolvency, and it likely won’t be the last. Decentralized infrastructure can prevent similar meltdowns from occurring. DeFi is still in its infancy, and more intuitive user interfaces and greater education are needed to take full advantage of the benefits the system can offer.

Investors looking to gain exposure to DeFi can do so by buying tokens from top DEXs such as UNI, CRV and SUSHI or lending protocols such as Compound (COMP), Aave (AAVE) or Maker (MKR). Investors can also stake some of these assets to earn a return and capture some of the revenue generated by the underlying protocols.

For users deciding which DEXs to trade on, Uniswap has the highest volume and highest total value locked, which means users are generally subject to less price slippage, the difference between the price that a user specifies and the one that is received. Aggregators like 1inch can be useful in finding the best prices for the assets users want to trade, but they usually add up to additional trades for a particular trade, resulting in higher gas fees.

Several centralized exchanges have launched exchange tokens such as FTT from FTX, CRO from Crypto.com, BNB from Binance, and LEO from Bitfinex. These tokens are usually structured as pseudo-equity instruments in which they burn tokens with a portion of the revenue generated from the exchange, thus linking the value of the token to the performance of the exchange. These tokens may also offer additional benefits such as trading fee discounts for holders. Ultimately, these tokens should be viewed as an equity investment in the exchange, with the risk of the exchange going down, in which case the token is rendered worthless.

At this point, centralized exchanges still provide a better and easier user experience, fiat on-ramps, and greater liquidity, but these are issues that DeFi apps can solve. However, users should be aware that DeFi applications always come with their own set of risks, such as potential regulatory risk, smart contract risk leading to potential hacks, and users’ responsibility to properly manage their private keys.