As DeFi lifts off, decentralised exchanges are spreading their wings
A handful of first movers have taken an early lead, but new DEX approaches are gathering momentum
The Decentralised Finance (DeFi) marketplace is on fire, with a growing hoard of DeFi-deposited assets now pegged at more than $100 billion —across a user base closing in on two million.
Following 2020’s torrid ‘Summer’ of DeFi’, the market has raced past milestone after milestone. Total value locked or ‘TVL’ (the DeFi equivalent of market capitalisation) hit $1 billion in February — on its way to $10 billion in September. It’s kept-up the hockey-stick ascent ever since.
Inside DeFi there are loads of emerging services and tech platforms, but the decentralised exchange (DEX) category is by far the biggest.
Companies like Uniswap and SushiSwap are offering crypto traders and investors a compelling alternative to centralised cryptocurrency exchanges (CEXs) like Coinbase.
Using a DEX, users can trade tokens without surrendering custody of their coins to a third party. A DEX relies on automatically executed protocols called ‘smart contracts’ that enable crypto trades between counterparties to happen without anyone taking custody of their coins.
Users can trade freely without the risk of having the exchange arbitrarily limit access to their crypto or restrict their ability to trade it.
But like any fast-moving segment, the DEX space is evolving. As it attracts more users and more liquidity, some of the limitations of earlier offers are starting to reveal themselves. The market is diversifying in response.
Emerging challenges and new solutions
Consider the issue of transaction fees. Most DEX’s operate on the Ethereum network. Ethereum is both the planet’s second-largest blockchain and a superior development platform, but there’s a downside: high transaction costs.
Transaction costs on established DEXs like Uniswap and SushiSwap can be punishing. They include the ‘Gas’ fees paid to Ethereum miners as a way to manage network congestion. Those can be as high as $50.
Newer players like Polkadex, PancakeSwap, and Polkaswap have stepped into the breach to offer a way around the problem.
PancakeSwap lets users swap tokens without a custodial middleman, plus earn rewards from discreet liquidity pools. Traders can stake their tokens to earn further rewards and take part in lotteries.
What sets PancakeSwap apart is its choice of development platform. Rather than build on Ethereum like most DeFi solutions, PancakeSwap’s project team chose relative newcomer Binance Smart Chain — and they say they can be more cost-effective as a result.
Binance Smart Chain is less established than Ethereum, but that also means less network congestion. Developers can take advantage of lower underlying transaction costs to keep their trading fees low, while also offering speedier transactions.
That makes their pricing and user experience more competitive.
With Polkadex, fees on standard market orders are a nominal 0.2 per cent, while high-frequency trades come with zero cancellation fees, meaning individual traders and institutions can enter and exit markets dynamically.
Polkadex’s founders say they offer these advantages thanks to the project’s use of Polkadot. Polkadot connects the myriad of specialist and mainstream blockchains with cross-chain bridges, opening the door to a wider range of blockchains, liquidity pools, and potential counterparties.
Without it, traders would be at the mercy of Ethereum miners, who naturally prioritise transactions with the highest gas fees attached. Polkadex ensures that trade execution is both snappy and cheap, so gains aren’t squandered in the interval between agreeing a trade and having it pulled out of the mempool for verification.
Polkadex’s off-chain order book promises to accept a trade in 20 milliseconds or less, and handle processing volumes of up to 500,000 trades per second.
If those claims come true, system-gaming tactics like frontrunning could become a thing of the past. Rather than prioritising trades by the ability to pay, transactions are handled on a ‘trustless’ basis, meaning it's first come, first served.
Polkaswap also plans to leverage the Polkadot ecosystem to connect mainstream platforms like Ethereum —and eventually Bitcoin —to other blockchains, coins, and tokens.
Its liquidity aggregation technology also aims to form a bridge between decentralised and centralised exchanges. Project leads hope to cater to users who want the user-friendliness of a Coinbase but also want access to a broader range of blockchains, liquidity pools, and potential counterparties.
Polkaswap says it will offer ‘smart’ liquidity routing to keep its pricing low, which means automating the process of locating and sourcing the best (e.g. most profitable / lowest cost) pool for any new order request.
If it works, it could mean more profit potential for individual trades.