Crypto exchanges face an existential challenge. What can bring users back?
A trend few have paid much attention to is the changing shape of the crypto industry’s spot markets – more specifically in the cross-chain space. What started on Ethereum spreads as technology advances.
In 2020, Uniswap exploded (in a good way) and took billions in daily volume away from centralized exchanges, to the point where much of the price discovery for many ERC-20 tokens now happens on-chain.
If the trend of the last two years is anything to go by, the same will probably happen in 2023 in other markets. With dozens of new tier-1 chains emerging and growing, and cross-chain technology getting better and more refined over time, it’s slowly becoming possible to exchange assets across chains in an experience comparable to Uniswap. Even Uniswap itself is expanding to other chains.
With multiple bankruptcies and collapses still filling crypto news feeds, it has never been clearer to users and regulators alike that the industry needs to reduce its reliance on centralized exchanges. When it comes to transparency and user control of customer funds, nothing beats on-chain trading through protocols instead of trusted devices.
There are still many issues plaguing cross-chain experiences, namely low liquidity, poor user experience, lack of aggregation, market fragmentation, and lack of support for non-Ethereum Virtual Machine chains.
Fortunately, cross-chain aggregators help bring together the patchwork of cross-chain messaging, bridging, and native exchange protocols out there. The nature of decentralized finance (DeFi) means that different protocols can come together in transparent partnerships – protocol interacting with protocol – to the benefit of users and the ecosystem in general. In fact, much of the time, such cooperation is not necessary. Protocols can use other protocols without permission from the other, removing even more barriers to this development.
It is a markedly different approach to a centralized environment where cooperation between competitors is quite unheard of. What this means is that the pace of development – and the ability to build resilience into DeFi – while slow to begin with, has all the ingredients necessary for rapid expansion, and strategic partnerships will play a key role in driving the growth of decentralized protocols. There is still a lot of work to be done to make this competitive with centralized exchanges, but Uniswap has proven that when liquid and accessible enough, there is nothing stopping protocols from attracting volume from the centralized exchanges for all crypto-to-crypto- exchange agreements.
This liquidity issue is more important than many realize, as crypto-to-crypto spot markets make up the largest fee-paying trades in today’s USD 1 trillion markets, and have done so since very early in history. Derivatives may appear to have more volume, but the apparent size advantage quickly disappears when leverage and different fee models are taken into account. When it comes to what users pay for in fees, the spot markets are and will continue to be fundamental to the industry. If the liquidity issue can be solved in a sustainable way, the spot market cash cow that the exchanges depend on could end up being absorbed by DeFi.
The remaining barrier to full adoption of on-chain spot trading in users’ minds is security. The past two years have provided far too many expensive lessons for chain providers of various kinds. In particular, bridges remain a risk to users due to the tail risk associated with packaging and the centralized nature of many bridge products. But as more efficient native cross-chain swapping becomes available, and the expansion of native-issued stablecoins to many more chains with their own spot markets continues, bridges become less important to users. Aggregators already help the user navigate their options, with security as a very real consideration. The collapse of FTX and others has shown that self-storage is essential for user security, and chain trading is the way to get there.
During the rest of 2023, users will likely be amazed by the rapidly improving exchange experiences on offer, and through close cooperation, the builders in this area will be able to invoke the “Uniswap Effect” on most crypto spot markets, just as it was done. to the ERC-20 token markets in 2020.
Users will gradually switch not only because of a desire for the principle of decentralization, but because these new experiences will be more secure, cost competitive, offer unprecedented access to assets across the entire ecosystem and remain maximally transparent.
Does this mean that Binance, Coinbase and so on will follow FTX to the depths of the deep blue ocean? No, but their market share of the spot markets is likely to decline throughout the year to the great benefit of both users and protocols. Centralized exchanges will continue to have an important role to play, especially in the “on and off ramp” stage where crypto interacts most closely with the fiat monetary system.
Ultimately, volume will flow to the optimal path of least resistance—and now is the time for those of us in the cross-chain space to present a compelling alternative to the status quo.
