Decentralized Exchanges Will Keep Growing, Even as Institutions Invest in Crypto

14 Oct 2020

Cryptocurrency exchanges play a major role in the crypto economy, serving as an on-ramp for anyone looking for a different option over fiat currencies and start managing their own money. Most crypto exchanges are centralized, run by one entity that could be seen as a single point of failure.

If an exchange’s operators decide or are forced to freeze a user’s funds, hand over customer data, or even manipulate the market, there isn’t much users can do. Exchange operators have to be trusted, and once trust is broken users move to another trading platform.

Decentralized exchanges have long been seen as a solution. Exchanges users can access with their wallets on the blockchain, without having to hand over any private information or without having to move their give up control of their funds. Security s however, also a concern with these trading platforms.

Decentralized finance (DeFi) protocols and decentralized exchanges have been exploited over the years. The first major case of a decentralized exchange getting hacked was that of EtherDelta, which saw hackers steal at least 308 ETH, then worth $266,000, and a number of ERC-20 tokens after hackers took over its DNS server to serve users a fake version of the website.

In some cases, these security breaches can be extremely severe. If a centralized trading platform is hacked, users can be reimbursed by the exchange, but if a decentralized exchange is hacked, their funds are likely gone.

The battle between centralized exchanges and decentralized exchanges is now taking new proportions. While centralized platforms are now embracing new roles – interest-bearing offers, educational resources,  crypto ecosystem promotions – decentralized exchanges are also evolving to become more accessible.

CryptoCompare caught up with representatives from some of the largest cryptocurrency exchanges in the space – including, OKCoin, Huobi, EXMO, and KuCoin – to get their thoughts on how the space is evolving, and what the future holds for cryptocurrency exchanges.

Decentralized Exchanges Will Keep Growing

Notably, the cryptocurrency exchange representatives CryptoCompare spoke with mostly revealed they believe decentralized exchanges (DEXs) are going to keep growing. 73% of respondents estimate that DEXs current market share of 5% will increase in two years time.

While 23.1% of respondents said DEXs market share will stay in the 5-10% range, 34.6% said it would go up to 20%, while an additional 34.6% said it could go as high as 30% of the market share. 

Despite most believing decentralized exchanges will in the future account for a lot more trading volume than they do now, most centralized exchange operators appear to be opting out of the DEX race. 48% of respondents revealed they have no plans to build a decentralized exchange, while 32% conceded they “may build a DEX in the near future.” 12% said they already operate a DEX.

Some exchange operators may be opting out of the DEX race because of the dangers associated with building a decentralized trading platform that anyone could use. Commenting on regulators’ potential approach to decentralized exchanged, Chief Architect at Telos Blockchain Douglas Horn told CryptoCompare:

“The sooner regulators look at their own rules as a high hurdle for even well intentioned crypto traders to hope to meet, the sooner they can find workable solutions for the advances of DEXs and DeFi.”

While it may just bolster financial freedom, it may also help criminals launder funds and finance terrorism. Regulators are likely to frown at any platform with no know-your-customer (KYC) and anti-money laundering (AML) checks in place.

Self-Custody May Not Be a Priority

When asked about the important features of decentralized exchanges that draw users from centralized exchanges in, most operators seem to believe that self-custody isn’t a priority and that rather users want to operate anonymously.

46.2% of respondents pointed out that decentralized exchanges do not enforce KYC requirements, while 19.2% pointed to self-custody. An additional 15.4% pointed to the current yield farming trend, where it’s possible to earn significant yield by interacting with decentralized platforms, thanks to the distribution of governance tokens.

11.5% pointed out the transparency of the market structure may be a factor drawing in users, while 7.7% believe users move to DEXs as these aren’t operated by a third party. These factors may be so important to users, centralized exchange operators still see featured their platforms will have over DEXs to attract users.

These include better liquidity (30.8%), compatibility with fiat currencies (30.8%), better user experience (19.2%), and a better customer service (11.5%), An additional 7.7% revealed that advanced trading features will also keep drawing in users to centralized platforms. Keep in mind, most believe DEXs market share will grow.

Only 11.6% of respondents said they believe DEXs will have a better user experience than CEXs in two years, while only 7.7% said they believe decentralized trading platforms will have better liquidity.

Crypto Space’s Reputation is Improving

From the responses, it seems that the reputation the cryptocurrency has is steadily improving, so much so that for centralized exchanges it’ has been getting easier over the last two years to find and maintain banking relationships. Only 4% of respondents said it was getting harder, while 56% said they were improving. 40% said they haven’t felt a significant difference.

Interestingly, 73% of respondents said they think it is likely exchanges will offer financial services for crypto and non-crypto assets. On top of that, 57.7% of respondents said they believe it is likely exchanges will start offering traditional assets in two years, while 23% said they didn’t believe this was likelier.

Just last month, crypto exchange Kraken saw the U.S. state of Wyoming approve its application to form the first Special Purpose Depository Institution (SPDI), a bank regulated in largely the same way as a standard bank. The new institution, Kraken Financial, will be headquartered in Wyoming and be the first regulated bank in the U.S. to “provide comprehensive deposit-taking, custody, and fiduciary services for digital assets.”

Improving the cryptocurrency space’s reputation would also mean institutional investors and high-frequency traders invest more in the space. 65.4% of respondents believe high-frequency trading will increase in crypto within two years,

Impressively, 92.3% believe there will be a rise in institutional investors investing in digital assets over the same period.

Moving Forward

The results of our survey seem to show that, over time, pure crypto-to-crypto exchanges will become more decentralized, while centralized trading platforms will keep on evolving to offer more financial services to cryptocurrency users.

Centralized trading platforms are set to keep on being a trusted on-ramp to the cryptocurrency space, and help further bank the unbanked, while decentralized crypto-to-crypto platforms will ensure financial services reach those that may have the wrong opinion, may be born in the wrong country, or may be working in the wrong industry or with the wrong group.

Speaking to CryptoCompare Stephen Stonberg, CFO and COO at cryptocurrency exchange Bittrex, said the evolving regulatory environment needs to “provide assurance to potential retail and institutional parties that their assets are being managed with the same guarantees as mainstream banks and asset managers would.” He added:

“Proper regulation will be fundamental to the long-term success and future of the cryptocurrency industry. With a clear framework in place, centralized exchanges can provide a safe and legal forum for investors to trade.”

In short, DEXs will ensure cryptocurrencies remain censorship-resistant, while CEXs will ensure they remain accessible. What that implies on the AML and anti-terrorist financing side may not be much. While crypto on-ramps will enforce KYC and AML cryptocurrencies can be exchanged for goods and services, bypassing on-ramps.

Large amounts draw attention on an open blockchain, and as such blockchain forensics firms may have an increasingly more important role as time goes by. Douglas Horn pointed out that while cryptocurrencies are “demonstrably not a major form of money laundering compared to cash,” people “would be wise to treat their use of cryptocurrency as public knowledge and follow all appropriate laws rather than hope for protection from the shield of anonymity.”

Horn added that the “supposed funding of terrorism and money laundering are red herring governments always offer to help legitimize their pursuit of the crypto community,” when in fact they care about “revenue collection and protection of the traditional financial system.”

A special thanks to Thore Network, KuCoin, CoinCorner, Huobi Global, LMAX Digital, EXMO, OKCoin, NDAX, AAX, GOPAX, and for participating in our survey.


Featured image via Pexels. 


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