*Migrated from Medium* Original Date - 02/08/21

One of the big calls of DeFi is that it stands to eventually topple CeFi, and what place better to start at than with exchanges? The rise of the DEX has been a feat in the making for years, but we only really started to see the logos of DEXes last year, when platforms such as Uniswap, Curve, Balancer, and Sushiswap came to the scene and managed to amass billions in liquidity. Billions is a cool number to throw around, but when compared against centralized platforms such as Coinbase, Binance, Huobi, and Kraken… it is not that big at all. To paraphrase DeFi investor Santiago R Santos (Partner @ ParaFi), DeFi can be conceived as a rounding error of CeFi’s volume… but all things do start small. eCommerce used to be a blimp in the sea of big retailers, fintech wasn’t known 20 years ago, and what happened to taxis again? Massive transformations begin at small scales, and there is a formidable argument for why DeFi is the next big transformation.

To convince one of that transformation, the best place to start at is looking into the rise of DEXes. A DEX, for those of you that are not familiar, is a ‘decentralized exchange’, and it describes an exchange platform that is not run by any entity, but rather the community (let’s hold the Almeda — SushiSwap counter back :) ). Liquidity is incentivized through coded economic incentives, and transactions are carried out using blockchain technology and smart contracts. While DEXes may sound scary, they aren’t bad at all, especially once you have crossed the hurdle of setting up a browser wallet and gaining some familiarity with the Ethereum ecosystem. DEX’s are truly democratic and accessible for anyone with an internet connection and some crypto — quite revolutionary one may say! The DEX is the ultimate progression in financial exclusion: in the 80s we needed a stock broker, in the 2000s we needed to pay fees on this and that and go through paperwork, and now we have a permissionless and global system that doesn’t rest on a corruptible entity. This post will first focus on why the DEX is a more favorable platform than the CEX (centralized exchange). Then, it will proceed to add some quantitative color to where we stand in the adoption curve, giving an insight into the impressive market opportunity that lays ahead.

Why use a DEX?

1. Less friction: After gaining some familiarity with Ethereum and crypto in general, the ability to trade nearly any crypto asset on a DEX is totally frictionless. You find the asset you want, you enter the asset you want to exchange it for, you pay some gas (possible financial friction here, especially at the moment), and you get your asset. This definitely beats any centralized exchange, which presents the following barriers:

• KYC. While I do understand the necessary KYC procedures concerning AML, I believe that many people are left out the financial system because of this, and, therefore, miss out on wealth creation and management opportunities available to the rest

• Fiat-to-crypto. Exchange some WETH for some ALPHA? That is a hard feat to accomplish on any CEX. Most offer USD/EURO/GBP based trades. It would be a pain to have to convert into those currencies, just to buy another asset when you can pierce straight through all of that on a DEX

• ACH. This is definitely an issue in the U.S. (Coinbase, Kraken, Gemini). Why do you have to wait 7 days to send an asset off to a browser wallet if you want to, say yield farm? I understand why Coinbase has to do it (not really their fault that the financial plumbing is old here), but why should consumers endure it? Uniswap takes seconds…

2. Fees. Well, let’s be honest, we all care about our transaction fees. Now, before I begin here, I do want to concede the point on gas — it is pricey at the moment with Gwei to the moon, but taking a step back, I am a believer in ETH 2.0, Layer 2 development, and chain interoperability; therefore, massive gas fees will be a thing of the past (think of dial-in internet… ). With proper scaling solutions implemented, transaction fees will be pennies on the dollar compared to the ‘network’ fees CEXs are skimming off every transaction. Even currently with gas, larger transactions still enjoy smaller fees on DEXes than on CEXes. **Fair point against this here is Binance’s incredible 0.1% fee… (conceded and highlighted below)

3. Asset availability. A CEX can’t really match up to a DEX - maybe Binance comes the closest to doing so as they are moving fast in addressing asset availability and ICO hosting (kudos to them). But still, for most seasoned participants, you will always look on Uniswap or Balancer first for that asset you heard on Twitter before you look on a CEX. While this point is more of a crypto-native one, it is still important nonetheless. In the future, other ecosystems such as NFTs will blossom, making the need for vast and diverse asset availability key. What better platform to have that on than one that lets users create liquidity around demanded assets?

4. ICOs. For those teams out there launching a protocol, it must be said that issuance fees and transparency are much better on a DEX. This is a bit similar to the Direct Listing vs. IPO battle going on now. On a DEX, the issuing entity is comparably more in control of the process

5. Hacking and vulnerability points. CEXs have your data, custody your assets, and are controlled by team of people at a company. This can lead to certain vulnerability points (bring in the calls to Mt. Gox) that could lead to risk of asset loss. Now, the main CEXs have been doing a great job with security measures (2FA, Vaults, etc.), but, if a user knows how to properly safeguard their assets, a DEX is a better choice. Note, to concede another point, that is a big if — for some people, Coinbase vaults and CEX custody services are a better solution

Given those 5 core points, it is also fair to list some of the disadvantages:

• Lack of fiat onramps: this is a tough pill to swallow, and something that the crypto world really needs to figure out. CEXs are the main and nearly sole way to bring on wealth to crypto ecosystems from the non-crypto world

• BTC and non-ETH denominated trades: this can also be a key point for certain crypto users who don’t want to be or are not part of the Ethereum ecosystem, where basically most of the DEX volume lies

• Cold storage: some CEXs offer cold storage solutions as part of your account. This is great for those that wish to have more security and don’t want to go the Ledger route

DEX vs CEX: the transformation so far

Looking at the 2020 progress of TVL and volume in DeFi is pretty amazing. The growth has been phenomenal, but the space is still in its infancy — this propagates both tremendous opportunity as well as risk.

So, where are we right now on the CEX vs. DEX battle? Let’s begin by going through a couple numbers.

Daily Trading Volume (stats from CoinMarketCap)

DEXes:

• Uniswap: $866m

• Sushiswap: $295m

• 1inch: $165m

CEXes:

• Binance: $22,471m

• Huobi: $6,983m

• Coinbase Pro: $3,135m

Average multiple on volume (CEX/ DEX): $10,863m / $442m = 24.6x. So, the positive surrounding this figure for DEXes is that it points to them controlling around 3–4% of the market — this signifies a massive TAM runway, and that is assuming no growth at all in crypto volume at all. The negative is that volume can be a driver of efficiency and a builder of moats… could this volume discrepancy be building a wall around a subset of crypto users? Given the pros of DEXs described above, I think not, especially in the long run. Needless to say, it still must be mentioned as a current disadvantage

Assets Listed (stats from CoinMarketCap)

DEXes:

• Uniswap: 1,246

• Sushiswap: 139

• 1inch: 718

CEXes:

• Binance: 331

• Huobi: 311

• Coinbase Pro: 46

Here, the script is flipped a bit. The average multiple on assets listed from DEX/CEX is 701 / 229 = 3.1x. If you are really trying to get involved in crypto beyond some blue chips and the ETH/BTC… then DEXs are the place to go.

Fees (stats from DApps and exchanges themselves)

DEXes:

• Uniswap: 0.3%

• Sushiswap: 0.3%

• 1inch: variable and based on DEXes it aggregates off of (can be considered sub 1%)

CEXes:

• Binance: 0.1%

• Huobi: 0.2%

• Coinbase Pro: 1.49% — 3.99%

Here, we are in a tough spot. Asian CEXs are doing better than DEXs! American CEXs are lagging behind both. I will have to concede to Binance on this one… but wonder about the sustainability of it all. And, of course, gas costs were not incorporated here… this would definitely tilt the scale towards CEXes, but I am trying to take a long-term view, and for that I assume we will solve the scalability issues residing currently with Ethereum.

Conclusion

Overall, I attempted to use some whitespace here to highlight where I see DEXes outperforming CEXes (note, I have some U.S. CEX exchange bias, which may have shaped some of these arguments, especially the fee one). Additionally, I provided some color around 3 key quantitative parameters, which tell us an interesting story — DEXes are a drop in the bucket market-wise, but offer more availability and lower/ constant fees (except against Binance (especially!)). I find the space truly fascinating and can see a future where DEXes flourish as they better address what crypto participants are and will be looking for. Yet, as mentioned before, there is risk in all of this; however, so was there in the internet. I look forward to following DEXes closely as I interact with and monitor them.

Disclosure:* This blog series is strictly personal/ educational and is not investment advice nor a solicitation to buy or sell any assets. It does not represent any views from where the author is working — all views, opinions, and arguments are the author’s. Please always do your own research.*