A decentralized exchange (or DEX) is a peer-to-peer marketplace where cryptocurrency traders can transact directly with one another. DEXs enable one of crypto's most fundamental functions: facilitating financial transactions that aren't mediated by banks, brokers, payment processors, or any other third party.
Every trade incurs a transaction cost in addition to the trading fee because decentralized exchanges are built on top of blockchain networks that support smart contracts and where users keep custody of their assets. In order to use DEXs, traders engage with smart contracts on the blockchain.
How is the volume of DEXs compared to CEXs?
Though established in recent years, DEXs have become a viable competitor to CEXs (Centralized Exchanges). After the launch of uniswap in 2018, many other DEXs came to live on Ethereum, Solana, Avalanche, and recently on Cardano. But how was the volume on these DEXs?
By looking at the above figure, one can see that Uniswap captures the higher portion of traded market share among DEXs. In April 2022, total traded volume was just above $105bn, and Uniswap captured $45.9bn of it. Additionally, one can see that in the month of November 2021 when Bitcoin made its all-time high, also the overall traded volume of DEXs made its peak.
However, by looking at the chart of DEX to CEX Spot Trade volume, one can observe at its peak, DEXs constituted just below 20% of CEXs volume. After the DeFi summer in 2020, usually the ratio was just below 10%. Through 2022, the volume in DEXs lost to CEXs, but recently there was a spike in the ratio in May 2022.
Usually, DEXs offer incentivization for liquidity providers (LPs), who provide tokens or coins for the given pool in the asset pair, to increase the liquidity on exchanges and to bring more capital. Usually, LPs are rewarded with the governance token of the exchange, especially, in the beginning, higher APRs attract lots of fresh money. Providing liquidity is usually called farming,
Also, by staking, similar to the one that you can do for staking ADA, exchanges attract other investors, who want to take less risks. By this way, investors can do one-way staking (only involving one coin or token) or two-way staking (involving two coins or tokens). By putting tokens or coins to the staking pool for the longer duration, usually received rewards increase as well.
What can be expected beyond 2022?
One can clearly observe that still the biggest portion of traded crypto spot volume is happening CEXs. Nevertheless, considering that DEXs are a phenomenon of recent years, it still captured around 10% of spot volume. As more crypto adoption is happening, more liquidity will possibly flow into the exchanges. Of course, DEXs will be gaining from that money inflow as well. At this point it is clear that incentivization only through the governance token is not sustainable in the long run. That’s why exchanges that have higher trade volume will attract more investors, because these are exchanges that generate cash flows and pay back to investors.
By offering anonymity, allowing users to trade freely, and not limiting the control to a central entity, DEXs are a direct competitors to CEXs, and this competition will get intense in the upcoming years.