Mahi Sall, Advisor, Fintech-Bank Partnerships, Payments and Financial Inclusivity
January 25th, 2023
Mahi Sall is the CEO & Founder of FinXpair, a Berlin-based strategic advisory boutique firm focu[...]
The Vanguard of Decentralized Exchanges (DEX)
Decentralized Exchanges | Oct 25, 2023
Image: Unsplash/Behnam Norouzi
The Decentralized Exchange (DEX) Market is Transforming
With a shift from Automated Market Makers (AMMs) to order book models, increased regulatory scrutiny, and continuous innovations aimed at enhancing user experience and security, here's a look at what's going on:
DEX Market Overview
- According to Coingecko who monitors 567 decentralized cryptocurrency trading platforms, the cumulative 24-hour trading volume of $3.01 Billion, reflecting a decrease of 35.25% within the last day.
- At present, decentralized finance (DeFi) commands a 3.4% share of the total trading volume.
- The top three decentralized exchanges leading in volume include:
- Uniswap V3 on the Ethereum network: $903,859,316
- Uniswap V3 on Arbitrum One: $337,482,788
- Pancakeswap V3 on the Binance Smart Chain (BSC): $166,417,095
See: Crypto’s 22 Billionaires & the Global Adoption Index
- Uniswap: Uniswap is the world’s biggest decentralized exchange, known for its user-friendly interface and ample liquidity. It allows users to buy, sell, and trade ERC-20 tokens on the Ethereum blockchain, and also enables participation in liquidity pools to generate yield.
- Curve: Curve is best known for its focus on stablecoin trading. It was originally designed to allow users to swap stablecoins of similar value, which helps protect liquidity providers and mitigate impermanent loss. It is considered one of the safest and most trusted decentralized exchanges in the space.
- 1inch: Unlike other decentralized exchanges, 1inch is a decentralized exchange aggregator. It searches different decentralized exchanges on the Ethereum blockchain to find the lowest fees and best prices for trades, ensuring cost efficiency for its users.
How DAOs Work for DEXes
Decentralized Autonomous Organizations (DAOs) or community governance models are becoming increasingly popular for decentralized exchanges (DEXes) as they offer a way to democratize decision-making and ensure that the platform operates in the best interest of its users. Here’s how they are working, along with the challenges and opportunities they present:
- In most DAOs, governance tokens are distributed to users, and these tokens grant voting rights. The more tokens a user holds, the more voting power they have.
- Community members can submit proposals for changes or upgrades to the platform. These proposals are then voted on by token holders.
- Decisions are made based on the outcome of the votes, ensuring that changes to the platform are in line with the majority of the community’s preferences.
- All proposals and voting results are recorded on the blockchain, ensuring transparency and accountability.
Challenges
- One of the biggest challenges is low voter turnout, which can lead to a small number of users making decisions for the entire platform.
- Users with a large number of governance tokens (whale dominance) can have a disproportionate influence on decisions, potentially leading to centralization.
See: ReFi Hackathon Is Calling All Hackers and Sponsors!
- The process of submitting proposals and voting can be complex and intimidating, especially for new or less tech-savvy users.
- DAOs are based on smart contracts, which can have vulnerabilities that might be exploited by malicious actors.
- The legal status of DAOs is still unclear in many jurisdictions, and there could be regulatory challenges in the future.
Pros
- DAOs can lead to increased user engagement and a sense of ownership and community among users.
- By allowing the community to propose and vote on changes, DAOs can foster innovation and ensure that the platform continues to meet the needs of its users.
- DAOs promote decentralization, reducing the risk of censorship and ensuring that the platform operates in a trustless manner.
- Alignment of Interests: Since governance token holders are usually also users of the platform, DAOs help to align the interests of users and the platform.
- Decentralized decision-making can make the platform more resilient to external pressures and centralized points of failure.
While DAOs and community governance models present significant opportunities for DEXes to operate in a more decentralized and user-centric manner, they also come with challenges that need to be addressed.
Evolution of AMM to Order Book Models
As covered by Cointelegraph, decentralized exchanges (DEXes) have shifted from Automated Market Makers (AMMs) to traditional order book structures given the limitations of AMMs, such as impermanent loss and slippage, transparent price discovery, and strategic trading advantages offered by order book models. Let's look at some key insights of this transformation that promises an enriched and more secure user experience leading to broader adoption of DeFi platforms.
- DEXes emerge as alternatives to centralized exchanges, mitigating challenges like security vulnerabilities and lack of control over private keys. DEXes still lag in trading functionalities found in traditional centralized exchanges and financial systems.
- The AMM model, popularized on platforms like Ethereum, addresses liquidity issues in DEXes but introduces challenges such as impermanent loss, slippage, and limited capital efficiency. The absence of diverse order types also restricts strategic trading.
See: Suspected Sanctions Breach? The UK Forces Crypto Exchanges to Immediately Report
- Traditional financial markets predominantly use order book models, ensuring transparent price discovery and enabling a variety of trading strategies through different order types.
- UTXO-based blockchains enhance the efficiency of order book systems, allowing for peer-to-peer trades, high concurrency, and transparent access to trading history and order book state. This integration promises to bridge the gap between centralized and decentralized trading.
By embracing order book structures and leveraging the capabilities of UTXO-based blockchains, DEXes are poised to overcome the current limitations of AMMs, offering enhanced transparency, efficiency, and strategic trading options.
Image: Unsplash/Milad Fakurian
The Future of DEXes
The future of decentralized exchanges (DEXes) is poised for significant evolution and growth, driven by ongoing innovations, regulatory developments, and shifts in user preferences. Here are some key trends and expectations for the future of DEXes:
- As decentralized exchanges are likely to face increased scrutiny from regulatory bodies. This could lead to the implementation of stricter compliance measures and KYC/AML procedures to mitigate risks associated with money laundering and other illicit activities.
- Future iterations of DEXes are expected to focus on enhancing the user experience, making it more intuitive and user-friendly. This could involve improving the interface, reducing transaction fees, and increasing transaction speeds.
- Security will remain a top priority for DEXes, with continuous improvements and innovations in smart contract design and other security measures to protect users’ funds and personal information.
See: Canadian Securities Regulators Publish Enhanced Investor Protection Expectations of Crypto Trading Platforms
- There is potential for greater integration between decentralized exchanges and traditional financial systems, bridging the gap between the two and providing users with more options and flexibility in how they manage and trade their assets.
- The future of DEXes will likely see continued innovation and diversification of services and products offered, including more advanced trading tools, yield farming opportunities, and integration with other decentralized finance (DeFi) applications.
The DEX ecosystem is resilient and poised for further innovation, adaptation, and growth, promising a more inclusive, secure, and user-centric trading environment within the decentralized finance space.
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