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Why are people starting to choose DEXes over CEXes?
Crypto-trading platforms stand as exchange sites that allow the trade of a digital asset or fiat currency for another. Around 2010 the first centralized crypto exchange was created, Mt. Gox started offering services to its users and allowing 24-hour trading of Bitcoin. Throughout the upcoming years many new centralized exchanges started to appear, many still offering their services today.
Ethereum was created as the first smart contract platform. It uses blockchain technology that allows the creation of smart contracts, allowing developers to create new protocolos using these smart contracts based on the Ethereum network. These protocols have the ability to interact with users in a decentralized way. Among a rising category of protocols on the Ethereum network were the decentralized exchanges (DEXes). DEXes basically offer a trading platform in a decentralized manner, all interactions in the system are between the user (through web 3.0 crypto wallets) and the financial provider being the DEX. The transactions do not depend on an intermediary (as in the case of centralized exchanges), meaning you have full custody of your assets during the transactions.
Coinbase is currently one of the biggest centralized exchanges in the market. Founded in 2012 the centralized exchange has been able to exponentially grow throughout the years, accomplishing a big milestone to many companies in 2021 being listed in the Nasdaq and started to be traded publicly. The exchange is often classified as the biggest U.S. exchange and has a current market cap of $42.55B.
One important indicator to keep track of is the volume of transactions being processed by exchanges. This helps assess how many people are using the platform and derive the fee revenue that the exchange is receiving from this part of the business.
Sources: IntoTheBlock & The Block
This indicator analyzes Coinbase’s volume of transactions since May 2020. The growth is evident: the exchange reached its highest monthly volume recorded in May 2021, being able to process around $200B. Even though the exchange’s volume has experienced a decrease since November 2021 and coming into 2022, it’s important to keep into account the significant growth experienced in this past year and a half. In May 2020 the exchange was processing around $11B in transactions volume, the exchange ended January 2022 having processed around $120B in the month, that’s a 1,000% increase in transactions volume in just one year and a half. What this essentially means is the more volume of transactions being processed, the higher the revenue to the centralized exchange and to their shareholders. Since the exchange charges a fee for every transaction being processed.
Uniswap is one of the first DEXes created on the Ethereum platform and currently among the ones with most traction. It launched in 2018 with its V1 version which soon started to process transactions and gain market share. The V1 version was later on followed by the V2 and V3 versions, being able to improve many aspects of the DEX along the way. Today its combined protocols stand as one of the top DEXes in the space. The protocol also has its own governance token, UNI, with a current market cap of around $7B.
Uniswap’s volume is also another important indicator to keep into account, since its volume also serves as reference to user’s DeFi adoption and the protocol utilization.
Sources: IntoTheBlock’s DeFi Insights and Uniswap.info
This indicator analyzes Uniswap’s transaction volume. Even though it’s not apples to apples, it’s relevant to bring this comparison since both Coinbase and Uniswap offer exchange services. Having launched in November 2018, 6 years after Coinbase, Uniswap has managed to capture an important share of the market in terms of exchange services. Recording an all-time high in transaction volume in December 2021, the DEX managed to process between its V2 and V3 versions around $82B.
What this brings to mind is, why are people starting to choose DEXes over CEXes? Besides having DeFi offer its privacy and security, people are also migrating for the yield opportunities available in the ecosystem, among these providing liquidity for DEXes like Uniswap.
The main difference between CEXes and DEXes trading services besides its decentralized process, is to whom the fees charged for the service goes to. In the case of CEXes since it’s a centralized company, they charge a fee for the exchange which they keep as part of the service as revenue. Since DEXes operate in a decentralized manner, they have liquidity providers (LPs), and anyone can become an LP by depositing into one of the DEXes’ permissionless pools. By becoming an LP to a DEX one automatically starts earning swap fees charged to the users trading through it. In other words, the DEXes revenue’s (swap fees) are distributed to the liquidity providers.
Finally one indicator that helps to illustrate this comparison is the fees generated by protocol indicator.
Source: IntoTheBlock
This indicator analyzes the fees generated by each protocol. Protocol fees are basically a small percentage of the transaction volume. In the case of Coinbase it typically charges users 0.5% of the amount traded, while in Uniswap’s case most pools charge 0.3% (though there are pools going as high as 1% and as low as 0.01%). The indicator gives a clear comparison of the fees generated by each entity. In May 2021, Coinbase reached a record high of around $1B generated on fees during this month for the platform’s usage. In this same way Uniswap recently recorded its record high in December 2021, generating around $246M in monthly fees, which are later on distributed to its liquidity providers. In essence, during the month of December 2021 Uniswap was able to distribute to its liquidity providers around $246M in swap fees.
DEXes keep on innovating and improving services for its users. Some of the most recent developments in DeFi are: the implementation of 0.01% fee pools for stablecoin trading on Uniswap and the continued growth and adoption of the 0.05% fee pools, which currently are the top ranked pools in Uniswap by trading volume. In addition, Uniswap has seen increasing traction from the deployment of the protocol in rollup solutions like Arbitrum and Optimism. This helps lower the cost of gas fees for transactions, combined with low fee pools, gives DEXes the ability to enter into a competitive field for the cheapest possible transaction in the market. As DeFi and DEXes keep on innovating in order to deliver the best possible service for users, while keeping the unique traits that make it up, we are likely to continue to see user migration and adoption into this new technology.
In conclusion, it’s important to keep these trends and user migrations into account. It’s also helpful to keep an eye out for opportunities in the rising DeFi ecosystem. DEXes offer great opportunities to get involved with the market and generate yield on your assets. Additionally it’s crucial to keep in mind and look out for certain risks that come along dealing with DeFi and DEXes in specific, like high gas prices or impermanent loss in the case of Liquidity Providers on DEXes. At last DeFi is a nascent and complex ecosystem which shows great potential.
Trading Platforms Evolution & New Trends to Keep in the Lookout For. was originally published in IntoTheBlock on Medium, where people are continuing the conversation by highlighting and responding to this story.
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