A sea change is underway in the cryptocurrency trading industry. Decentralized exchanges have suddenly and seamlessly become the exchanges of choice for day traders when less than a year ago, such a proposal would have seemed unimaginable.
Too many traders from the 2017 Bitcoin Bubble recount their woes at their use of decentralized exchanges. The scars of misplaced orders with an extra zero or not enough zeroes haunt the nightmares of many who attempted to get around KYC rules at centralized exchanges (CEX) since that time. Traders recount their woes at the abysmal and downright precarious user interface at EtherDelta which, although perfectly free to use for any trader, certainly came off as a cheap substitute to glorified CEX. We may never know how much money traders have lost due to countless failed transactions and erroneously entered orders on the DEX of a few years ago.
To that, CEX are just that: glorified. Their glory comes from a wide mix of self-aggrandized bombast, promises kept which afford them earned accolades and promises broken in the way of hacks which can afford them glory on the rebound depending on how quickly they recover the status quo.
The general reputation that CEX have, however, betrays the market’s true trust in their ability to vouchsafe a user’s wealth in the way that traditional banks can and do. Mark that in South Korea, most of the major exchanges (Bithumb, Upbit, and Coinone) among several others have fallen victim to cyber security attacks at one time or another. The more these attacks happen, the more disappointment traders felt in a market that begs to be taken seriously but cannot yet patch the holes in its pockets. With the suspicion that several hacks were even inside jobs perpetrated by the exchange operators to cover their costs or for other reasons, CEX have an uphill battle to fight in order to maintain a positive public image.
Additionally, the trustworthiness of exchange operators has repeatedly been brought into question. Again in the cases of Bithumb and Upbit, fraud has emerged as a serious issue time and time again. Wash trading has historically taken place rampantly at exchanges in order to keep their appearances up. Since 2019, wash trading subsided for various reasons through to the present with estimates that only one of the top-10 exchanges by daily volume fakes the majority of their volume. Furthermore, there is the case of Canada’s QuadrigaCX exchange who’s CEO allegedly passed away and took the private keys to the exchange with him. That is, until the exaggerated rumors of his death were investigated and led to calls for exhumation of his body circulated as far as the BBC. As it turned out, the CEO was over a hundred million dollars in debt because he took users’ funds to trade in his own accounts and lost on his picks.
CEX vs. DEX
One trader who wished to remain anonymous explained succinctly that “traders don’t want to rely on yet another 3rd party to take custody of assets which we can hold just fine on our own. I’ve never been hacked – how much did centralized exchanges lose in hacks last year alone?”
With DEX currently shattering daily and monthly volume marks from CEX, and even coin launches forgoing with the traditional CEX listing events, it is time players int he market asked themselves: Should traders use decentralized exchanges more or stay with the legacy centralized exchanges?
To help answer the question, representatives from CEX and DEX have weighed in. Their statements will be shared with limited commentary but with enough analysis to hopefully distill their ideas into accessible bits that laypeople will find easily accessible.
To start, CEX are required to abide by the laws of the countries they operate in just as any financial company would. These laws are designed to protect users both from nefarious actors and from themselves. KYC laws protect the exchanges from condoning money laundering. Periodic lockouts due to changing a password or failing to properly enter a 2FA key protect users from potential fraud on their own account. These are features that cannot be found on egalitarian, laissez-faire DEX.
Arguments for the centralized exchanges
Paolo Ardoino, CTO of Bitfinex commented on the debate regarding the merits of exchange options for traders. “Decentralized exchanges have their advantages; they are non-custodial solutions and everything runs on chain. However, blockchain nodes can frontrun users’ trades on DEX, lack KYC limitations, and have limitations in capacity… Centralized exchanges will continue to play a pivotal role in the cryptocurrency ecosystem by providing the regulated environments required for digital assets to evolve into the mainstream. For example, Bitfinex saw a 90% increase in KYC verification requests in August.”
Ardoino points out how some trading pairs on various DEX have limited capacity, alluding to the low liquidity available for them. New traders will struggle to understand why their buy order cannot be filled due to the slippage it would cause or due to the lack of liquidity. CEX are required to show proof of the liquidity available to back the transactions they support.
DEX rely on the community to provide the liquidity needed to perform trades. Companies that wish to list their tokens on DEX are also expected to provide sufficient liquidity to keep transactions moving smoothly. Users of CEX trade safely with the expectation that the system on the exchange will facilitate the completion of their orders.
Ignas Tauras of South Korea’s Hanbitco points out further advantages currently unavailable to DEX. “Centralized exchanges are and will remain the most cost efficient fiat gateways, thus attracting the majority of new defi users… The nature of blockchain immutability means that mistakes in interacting with DEXes and defi can be costly. On the other hand, CEX have well-developed customer service [programs] that can revert transactions, refund lost money, and offer VIP services to the most loyal/active users.”
CEX serving as the sole officially regulated fiat gateway for crypto traders remains the truth. Therefore, CEX should be the genesis of traders’ entry into crypto trading. Then within the better exchanges themselves, there are programs designed to help traders trade more and keep them satisfied with their experience. Lucrative VIP programs provide users with great flexibility and lower fees compared to other users, thereby encouraging more trading. Also, fraud detection is presumably much higher on CEX than DEX as demonstrated by the recent Kucoin hack.
Arguments for the decentralized exchanges
Cryptocurrency traders have made the call for more decentralization in the market reverberate louder than ever. The numbers speak for themselves in that regard. Dune Analytics publishes the eye-popping trade volumes and correlated revenues for DEX.
The 30-day volume at DEX through September 29th stands just above $24 billion. Uniswap accounts for the majority of that volume with about $13.8 billion and Curve comes in a distant second at about $5 billion. These are impressive volume rates which put them near the top of all crypto exchanges, including CEX. It appears to be a case where the market, when allowed to govern itself, can choose their preferred exchanges, they opt for those with the least friction and barriers to entry.
Things are not what they appear, however. Note that despite the astonishingly high trade volumes and certainly tremendous levels of profits for the liquidity providers, they are simply fresh entries in an industry that has weathered decidedly stranger occurrences. DEX as a whole broke the billion dollar mark in monthly volume only this past July. Also, the total 12-month volume across all DEX sits just below $46 billion. That means that the current standing 30-day volume accounts for more than half of all the volume in the past 12 months.
The issue remains that DEX are unproven. Even seasoned traders realize the risk in just visiting some unsecured DEX sites that do not have https options. Moreover, the uncertainty of what happens to orders stuck in ‘pending’ because the user did not spend enough GAS makes many stay weary of the functions that DEX offer. All of this is not to mention the fees which verge on the astronomical at times.
A bar graph shows the level of growth over the past 12 months at DEX trade volumes. Current daily trade volume across all DEX 9/29/2020 30-day DEX trade volume from Sept. 29th, 2020. Total aggregated 12-month DEX volume 9/29/2020
As a result, several DEX have already offered upgraded services, promised lower fees, promised to eliminate impermanent loss to liquidity providers, and various other upgrades. It indicates a corner of the market fast in motion.
Proponents of DEX claim that the fees are worth the cost to be able to trade anonymously and without having to login to another site. DEX do not require logins, just to connect a hot wallet for trading. A trader from the TheNews.Asia community added that the amount of lucrative opportunities for profit currently, and maybe only in the present, can be found mostly on DEX since crypto companies are choosing to list on DEX first and CEX second. Traders get the chance to earn rewards from coin pumps and from providing liquidity to an active trading pair pool.
DEX facilitate free and easy listing for a crypto, and they force CEX to reduce costs on listing fees.
Conclusion?
A conclusion may be some time off when decided which platforms are better. We may see swings of sentiment back and forth between decentralized exchanges and back to centralized exchanges between the present time and a year from now. It should be noted that while DEX have business interests in mind in regard to the fair pay for the fair work they do, CEX have concerted, cold, calculated profits in mind.
As the market continues to mature, CEX will incorporate and sell shares in their companies. This proliferation of ownership in crypto-related enterprises means shareholders will have a greater say in the direction of the company with the express goal of making profits. It would be folly to expect egalitarian ideals to defeat the narrow focus of profit-minded investors. On the other hand, profit-minded investors have so far made DEX the go-to place for some of the best coin launches in this current bull market.
Time will tell us the outcome.
