We were promised great things from decentralized exchanges (DEXs). They would usher in an era of noncustodial trading. Every trader would control their keys and coins at all times. That UX improvements were just around the corner, and soon trading on a decentralized exchange would be indistinguishable from a centralized one (CEX). We were misled: those claims were greatly exaggerated.
That’s not to say we were outright deceived about the capabilities of decentralized exchanges – they have improved enormously since the days of EtherDelta, whose user experience was about as pleasurable as a 19th century tooth extraction. In fact, great leaps have been made over the last 18 months in improving every major aspect of decentralized trading, from deploying more responsive trading engines to improving liquidity and reducing slippage. The number, scope, and quality of DEXs are light years ahead of where the industry was at in 2017, and yet to look at the trading volumes, you wouldn’t know it.
In the last 24 hours, Binance DEX, the leading decentralized exchange by some distance, has recorded just $1.3 million in volume, versus a global total of $26 billion. In other words, Binance DEX accounts for just 0.005% of all crypto trading. If Binance, with all its muscle and dominance of CEX trading, can’t lure the masses to DEXs, who can?
The Long, Slow Road to DEX Adoption
In a talk at decentralized finance summit Crypto DeFiance in Singapore on November 16, Nate Hindman had some light to shed on the state of DEXs today. The head of growth at Bancor began by discussing the state of play in 2017, when some in the crypto community expected that DEX trading volume would eventually overtake that of CEXs. If this were a documentary, it is at this point that the narrator’s voice would interject to say “It didn’t.” The reality is that CEXs strengthened their grip on the cryptoconomy, pulling further ahead of DEXs. As Hindman points out, DEX volume is now more than 1,000 smaller than that of CEXs.
Today, expecting decentralized exchanges to become the dominant trading mechanism appears about as realistic as expecting that altcoin you bought in 2017 to do a 1,000x and reach its former all-time high. That’s not to say DEXs are dead in the water though – far from it. In fact, the decentralized trading environment today is significantly more robust and user-friendly than ever. The user experience is now close to that of CEXs, which is thanks in no small part to the rise of liquidity pools. These aggregate tokens across multiple platforms and from multiple liquidity providers – i.e users – resulting in a decentralized trading experience that is far more pleasurable. It is also, crucially, far more profitable thanks to the reduced slippage through the improved order book depth that DEXs bring.
The greatest manifestations of the trend toward pooled liquidity come courtesy of Uniswap and Bancor, with Kyber also a contender. Between them, these decentralized protocols have close to $35 million in assets locked up. Not a huge amount in the grand scheme of things, but enough to show that there is still sustained interest from traders in utilizing DEXs.
Why DEX Adoption Has Stalled
There are a number of reasons why DEXs have lost ground to CEXs. One is the enforcement of KYC on leading DEXs, most notably IDEX, which has added friction and reduced privacy, removing one of the primary value propositions for using a decentralized exchange in the first place. Today, IDEX struggles to pull in half a million dollars of volume a day. There’s another more pressing reason as to why DEXs have been struggling, however, according to Nate Hindman – liquidity.
As he explains, “While DEXs make it relatively easy for users to connect their MetaMask and to select tokens to buy and sell, once users get to that final step of converting, they often encounter high slippage or high spreads, or just can't convert due to low liquidity on DEXs.” Bancor’s head of growth then expounds on the rise of liquidity pools as a solution to this. Liquidity pools, he explains, “turn market making into a couple of clicks, so that everyday users can add liquidity to a decentralized exchange, and in return receive a share of the exchange’s revenue.”
Hindman, as one would expect, is bullish on the potential for decentralized liquidity pools to “completely reinvent asset exchange, to eventually help DEXs form a vastly larger share of total crypto volume.” He also cites proponents of this model who have spoken of liquidity pools being a “Google moment” for defi. Two years from now, it will be possible to reappraise this bold prediction of decentralized trading and see whether it has come to pass.
Due to the rapid expansion of the cryptoconomy, it is possible that DEX adoption and liquidity could grow, while still falling further behind CEXs in terms of total volume. Whether such a scenario could be interpreted as success or failure depends on whether you’re a glass half-full or half-empty person. Advocates of decentralized trading will aver that a future in which anyone can trustlessly trade assets, quickly, easily, and simply, is one worth fighting for. Just as it is utopic to expect all trading to occur on DEXs eventually, it is myopic to assume that the current impediments to broader DEX adoption won’t be resolved. In the theater of ideas, the concept of decentralized trading has been firmly planted. Like all ideas that gain traction, this one won’t be easily banished.