Today most of the trading volume of Cryptocurrencies is happening on centralized exchanges like Coinbase, Binance, FTX, Gemini, Kraken, etc. These are closed trading platforms where customers open a custodial wallet account and trade with liquidity providers that are allowed into the platform by the company. They have undisclosed bid/ask spreads and charge transaction fees in the 1–2% area. While these companies make it easy for newbies to buy Crypto, they are not great value propositions to their users.
An alternative to these options is to trade on decentralized exchanges (“DEX”). On a DEX, a user connects their Crypto wallet, and enters trades through a blockchain protocol to an open market of liquidity providers. Transactions are matched through these liquidity pools. Reserves and prices are updated automatically every time someone trades. There is no central order book, no third-party custody, and no private order matching engine.
The providers of the tokens to the liquidity pools on a DEX set the trading fees, which is typically much lower than their centralized competitors. For the more liquid Cryptos, the fee is 0.3% or lower. However, the fee can get up to 1% for less common coins. Either way, much cheaper than trading on Coinbase.
On centralized exchanges, the management of Coinbase or FTX must approve a new addition. They make this decision based on the size of the market for that coin, the reputation of the project, and the availability of liquidity providers. This is done to protect users from buying tokens that can quickly become worthless or hard to trade. Nothing like this exists for a DEX. Anyone can add a new token to a DEX by simply providing liquidity of that token to a pool. There are no protections for users. It is all on the user to know what they are buying and find liquidity in the future. There are 50,000+ trading pairs available currently on DEX, a stunningly large number compared to about 300 on Coinbase. Choice is generally good, but most of the coins available for purchase on these decentralized exchanges are worthless.
The biggest DEX is Uniswap, launched in 2018 by a developer called Hayden Adams in response to an idea put forth by Ethereum founder Vitalik Buterin. Uniswap received some of its early funding from grants by the Ethereum Foundation to get open for business, and Adams credits Vitalik with coming up with the name for the company. The company surpassed $500Bn in lifetime trading volume in October 2021. They are ranked in the top 10 for trading volume when including the centralized exchanges.
While the trading is decentralized at Uniswap, the company is not. Uniswap is backed by leading Crypto venture firms including A16Z, Paradigm, and Union Square Ventures. Coinbase is also an investor in Uniswap. The company is governed by the $UNI token, which sports a $7Bn market cap. In September 2020, the company rewarded all 250K+ users that had completed a trade on Uniswap with 400 $UNI tokens, which was worth about $1,400 back then.
Two of the larger Uniswap competitors are called PancakeSwap and SushiSwap. Most on the competitors to Uniswap claim to be cheaper or faster than Uniswap. These DEX see some trading volume, but not nearly enough to break into the top 10 global exchange lists. SushiSwap got started in 2020 by launching a “vampire attack” on Uniswap. This colorful strategy is done by sucking the liquidity providers from Uniswap over to the new SushiSwap platform. Since everything on the blockchain is open and available, it is easier to do this than you would think. Liquidity providers are rewarded with $SUSHI tokens for making the switch. We have seen other vampire attacks done in the NFT marketplace sector as well, so expect to hear more about this strategy in the future.
For now, centralized exchanges still dominate the Crypto markets. However, DEX hold an important space in the Crypto stack. You can expect to hear more from me about these in the future.
*Thanks for subscribing to the Crypto Executive Guide newsletter. Please help me get the word out about Crypto and web3 by sharing this with a friend.*