By Huy Nguyen, CTO and Co-Founder of KardiaChain
The pace of growth in the cryptocurrency exchange markets has been nothing short of startling. This year, as Bitcoin’s market cap passed $1 trillion, Coinbase became publicly listed, and now Kraken is preparing to go public. Investment is pouring into the DeFi space, with decentralized exchange dYdX recently pulling in $65 million in a Series C round, as one case in point.
2021 is proving to be a pivotal year for crypto, with the global market cap reaching a new all-time high, institutional interest picking up, and innovations like NFTs putting crypto at the top of global headlines. If there was ever a time to question existing paradigms, then it’s now. And the fact is that despite the significant growth in the crypto markets, there are legacy problems that exist as a result of how the industry has evolved into centralized and decentralized branches.
From CEXs to DEXs
Centralized exchanges were the first to emerge in the earliest days of crypto. One of the most famous, Mt. Gox, ended up becoming a cautionary tale for the single biggest issue that continues to plague cryptocurrency exchanges to this day – fund security. At the time Mt. Gox was hacked in 2014 when attackers stole $450 million in BTC, it was handling 70% of all bitcoin transactions worldwide.
Centralized exchanges came about in response to demand, as crypto had grown in popularity and people wanted to trade. But there had always been a vision of decentralization using blockchain. Although it’s not necessarily a panacea for being hacked, the idea behind a DEX is that with smart contracts governing operations, exchanges can remove the vulnerable human element, which hackers tend to target. When Ethereum launched smart contract functionality in 2016, the decentralized exchange (DEX) finally became a real possibility.
The first generation of Ethereum-based DEXs such as Etherdelta failed because it used the order book model. Without a critical mass of users, there was simply not enough liquidity to sustain a market. It was only once projects such as Uniswap and Bancor started launching their automated market makers that the DEX market started to seem viable.
DEXs – Far From Perfect
Uniswap’s success is laudable and deserving, given the extent to which its accelerated growth in the DEX segment. However, there are several critical issues with the platform, Ethereum’s high fees being one of the most obvious. But it’s also worth mentioning that new users have a steep learning curve and high barriers to entry for Uniswap. Despite this, the platform doesn’t offer any sophisticated trading tools or special order types of the kind that would appeal to advanced traders migrating to crypto from other markets.
Since the 2017 bull run and in the time it’s taken Uniswap to get up and running, the centralized exchange market has become massive. Even so it’s still fraught with the same old issues, as demonstrated by last year’s attack on KuCoin – the third-biggest ever after Mt. Gox. Furthermore, the centralized exchange market is fiercely competitive to the point where now, a handful of large exchanges dominate. However, regulatory concerns and strict listing requirements mean that many of the biggest, such as Coinbase or Gemini, only offer users a limited array of tokens.
And thus, the DEX market also expands, fed by users looking for what the centralized markets can’t offer – a large array of token pairs and ownership of funds. DEXs are now springing up on every platform, but almost all are a direct clone of Uniswap. Moreover, there are varying degrees of compatibility and interoperability.
We Need a Different Perspective
So at this point in time, as cryptocurrencies gain global recognition on a world stage, it seems that the lion’s share of investment is going into maintaining the status quo. Namely, centralized exchanges providing an onboarding experience with a newcomer-friendly user interface but dubious security and limited token pairs. On the other side, DEXs that exist only to serve crypto natives who have put in the hours down the DeFi rabbit hole.
Furthermore, a deeper issue and growing issue is that this model simply fragments liquidity – a situation that isn’t needed in any growing market.
There needs to be a different way. Crypto needs to start providing exchanges that focus on resolving these challenges and not presenting an either/or dilemma to users. An exchange that offers a set of trading tools and order types, fast settlements, low slippage, low fees, and without compromising on the security of decentralization, or the range of tokens on offer, would have a significant market edge over the competition. It would appeal to both new and advanced users looking to trade and explore DeFi.
Cross-chain interoperability will also be a significant enabler of liquidity, allowing users to transfer funds seamlessly across platforms without needing special tools or interfaces.
Those who build decentralized exchanges with these challenges in mind will be best placed to support the inflow of new users as cryptocurrencies continue to grow as an asset class. In doing so, they’ll provide a blueprint for how exchanges should be developed and launched in the future.
Huy Nguyen is the chief technology officer and co-founder of KardiaChain. Huy is a senior tech lead manager at Google, with over 10 years of experience in building large-scale distributed infrastructures. Huy has a track record of leading many high profile projects, most notably Google Access Wireless Platform and Google Fiber Network Infrastructure.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.