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An analysis of decentralized digital currency exchanges

Decentralized digital currency exchanges (DEXs) have received significant attention in the digital currency community of late, often positioned as an alternative to centralized exchanges. Nearly 250 projects are attempting to build out a DEX, and among these, 80 platforms are already operating in some capacity. Additionally, several centralized exchange operators have even begun putting efforts behind building out DEX marketplaces. In August, the largest exchange by adjusted market cap, Binance, announcedthat the company was planning a DEX platform. Given the interest from the community and exchange operators, we analyzed and compared key exchange metrics to determine the success thus far of DEXs vs centralized exchanges and where future difficulties lie. Our findings demonstrate that DEXs, in their current state, need significant improvements in order to challenge centralized exchanges.

Background on Decentralized Exchanges

Currently, there exist several different variations of decentralized exchanges as the degree of platform decentralization lies along a continuum. In the simplest sense, a decentralized exchange is a platform that relies on a decentralized blockchain network, allowing users to trade assets peer-to-peer without relying on a centralized entity for liquidity or asset custody.

At the farthest end of the decentralization spectrum, a DEX would also allow users to execute trades without satisfying any regulatory intermediary steps (KYC, AML, etc) and list new tokens directly without needing third party regulatory or other approval. Centralized exchanges, on the other hand, control the custody of traders’ assets and must comply with local and national regulatory bodies which can impact customer services, asset trading, fees, and new token listings.

The perceived benefits of DEXs are quite clear. Nearly 6% of the total circulating supply of bitcoin have been hacked while custodied at centralized exchanges. Since 2011, more than $1.3 billion in digital currencies have been stolen from centralized exchange platforms (see figure 1 below). Most recently, the Japanese digital currency exchange, Zaif, was hacked on September 14, 2018, when access to one of its hot wallets was compromised. This breach resulted in approximately $60 million in digital currencies being stolen. Additionally, centralized exchanges have been rumored to manipulate asset prices, charge high listing fees, and are subject to often stringent laws which can result in a platform shutdown.

Figure 1: Digital Assets Lost in Hacks at Centralized Exchanges

Data for table sourced from Coiniq


Trading Volume Comparison between DEXs and Centralized Exchanges

DEXs have seen significant interest, yet this does not appear to translate into high trading volumes as DEXs currently transact in a small percentage of the digital currency trading volume that centralized exchanges do. In order to compare evenly across both categories, we analyzed trading volume for the most active trading pairs at the largest US compliant centralized exchange, Coinbase Pro, and trading volume at the current leading DEX by volume, IDEX. To ensure data integrity, we used data from the TradeBlock Professional platform, which connects directly to all of the leading exchanges. Below, we delineate trading volume at Coinbase Pro for the top three most active currency trading pairs over time.

Figure 2: Coinbase Pro Trading Volume (USD) YTD 

Data for chart sourced from the TradeBlock Professional Platform

Similarly, we analyzed trading volume year-to-date for IDEX. Given the constant changing nature of the most active markets on IDEX over time, we aggregated total trading volume on the exchange.

Figure 3: IDEX Total Trading Volume (USD) YTD

Data for chart sourced from DappRadar

As shown in figure 2 and figure 3 above, both exchanges have lost significant trading volume as digital currency prices have fallen in Q3-Q4. For the most recent month, Coinbase Pro facilitated more than $2.9 billion in trades. In comparison, IDEX facilitated less than 1.2% of Coinbase Pro’s volume–just over $33.5 million in trades.

Additionally, while centralized exchanges have begun to see a near term increase in trading volume amidst increased volatility this past week, DEX volume remains subdued. In the chart below, we diagram aggregate transactional volume for the three largest US compliant exchanges as well as the three largest DEXs (IDEX, ForkDelta, and Kyber Network) over the past 90 days.

Figure 4: Aggregate Volume (USD) on DEXs and Centralized Exchanges 

Data for chart sourced from the TradeBlock Professional Platform and DappRadar

Not only do DEXs transact in a fraction of the volume of centralized exchanges, DEXs have also seen volumes fall by a modestly larger percentage since their peak. Despite still being in its nascent stages, IDEX has seen transaction volumes fall more than 88% since it reached peak levels in May. Coinbase Pro, likewise, has seen its volumes fall significantly but to a lesser degree–down 85% since trading volume on the platform peaked in January 2018.  


Ether Gas Costs and Trading Fees Make DEXs an Expensive Alternative

Further, decentralized exchanges are often more expensive to trade on than centralized exchanges. While some DEXs offer lower trading fees than their centralized counterparts (see figure 5 below), the total cost to trade becomes higher once gas costs are factored in. Below we diagram trading fees (in basis points) for each exchange. It is important to note that centralized exchanges often have tiered fee schedules, in which traders who transact in larger volumes are charged lower fees. Figure 4 only shows the lowest tier (highest trading fees) for centralized exchanges. Among the largest DEXs, none offer a similar tiered fee schedule.

Figure 5: Trading Fee Comparison between Centralized Exchanges and DEXs

Data for table sourced from corresponding exchanges

In order to utilize the computational power of the Ethereum network, users must pay miners gas in the form of ether in order for their transactions to be confirmed. Since the majority of DEXs are built on the Ethereum blockchain, any transaction on these exchanges requires gas. Gas costs can vary over time as the usage of the Ethereum network changes. When there is greater demand to use the network, and a large backlog of transactions forms, miners can alter their rig settings to only accept transactions with gas prices that meet a certain threshold. As such, participants must then increase the price they are willing to pay in order for their transactions to be confirmed in a timely manner. During periods of heightened activity, users of Ethereum based applications can see their transactional costs increase significantly.

There has been one period (early 2018) that saw substantially heightened use of the Ethereum network above average levels resulting in high gas prices (see figure 5 below). During the bull market in early 2018/late 2017, the Ethereum network recorded heavy usage as trading volumes rose and as a popular decentralized application (dApp) named CryptoKitties launched on Ethereum mainnet.

CryptoKitties is a dapp built on the Ethereum blockchain that allows users to create and trade digital cartoon cats as collectible items. When the CryptoKitties dapp reached its peak (14,000 daily users in December 2017), Ethereum network transaction requests almost doubled  from around 622 thousand to 1.07 million–this information can be found on TradeBlock’s ethereum blockchain explorer.  

Figure 6: Average Ether Gas Prices Over Time

Data for chart sourced from TradeBlock’s Ethereum blockchain explorer tool

Total gas costs associated with trading on a DEX become variable as the gas limit in order to execute trades on the platform is not constant. The gas limit is the maximum amount of units of gas one is willing to spend on a transaction. While this can be varied depending on the DEX, the largest DEX by trading volume, IDEX, has a standard amount of gas that is used on each transaction.

On each transaction, IDEX requires 140,000 units of gas. To arrive at a total gas cost (gas used * gas price = total gas cost) to utilize IDEX, we must factor in gas prices. At peak prices in January, one unit of gas, on average, was priced at 0.0000000957 ETH ($0.000104403). Using 140,000 units of gas during January for one transaction on IDEX then, would have cost $14.62.

Today, gas prices have fallen significantly from January levels. The average gas price at time of writing is 0.000000014521834338ETH ($0.0000030612). Using 140,000 units of gas at today’s average prices, one transaction on IDEX would cost $0.43. This cost is much less than it was in January, yet still represents a large additional cost added on top of trading fees.

While this additional fee is a small percentage of the total order if a trader is transacting in large sizes, this cost can become quite large for smaller trades. Given DEXs often do not have substantial volume, order sizes are unlikely to be very large. To estimate trading costs for the average IDEX trader, we analyzed the average ETH transaction size on IDEX over the past seven days.

Over the past seven days, the average size of a transaction on IDEX was 0.338 ETH ($57.18 using our ETX index prices for the past seven days). At $0.43, today’s gas costs would resemble an additional 75 bps in gas fees for the average transaction on IDEX. If we assume orders in January were of the same size, gas costs for trades executed in January would resemble an additional 3.49% in gas fees above trading fees. Further, given that many traders will need to incorporate gas costs into their expense calculations prior to placing an order, as canceled orders will still incur gas fees, managing this process is an additional difficulty.


Centralized Exchanges offer more Active Trading Pairs than DEXs

While DEXs often have higher fees and currently transact in lower volumes than centralized exchanges, they should ideally outperform in areas that may be negatively impacted by increased regulatory burdens which can hamstring centralized institutions. Because of their decentralized platforms, DEXs are often touted as having the ability to operate outside of regulatory constraints, such as US security laws, and can hence launch an innumerable number of digital asset trading pairs. This, however, does not appear to be playing out.

Currently, centralized exchanges offer more active trading pairs than DEXs. Below, we diagram the number of active markets on the top regulatory compliant US exchanges and the top DEXs. As shown in figure 6, centralized exchanges offer, on average, nearly 50% more trading pairs than DEXs.

Figure 7: Active Markets on Centralized Exchanges vs Decentralized Exchanges
Data for chart sourced from corresponding exchanges


DEXs Face Similar Regulatory Constraints of Centralized Exchanges

Part of the reason decentralized exchanges have not been more aggressive at adding new pairs is that certain aspects of these exchanges remain centralized. The token listing process is one such area that has not been successfully decentralized. We analyzed the largest DEXs by trading volume, and found that only one exchange, The Token Store, allowed users to directly add a new token without needing the exchange’s approval. It is important to note, however, that even this exchange maintains two trading pages, one with approved trading pairs and one without that is on a secondary page.  

Other leading DEXs have varying requirements for the token listing process–but each requires at a minimum approval from the exchange. IDEX and ETHfinex are the most stringent in terms of new token listings and attempt to satisfy regulatory requirements. IDEX has a clause stating that the platform will not list any token that offers a dividend, in a nod to US security laws which would label such tokens as securities. ETHfinex requires potential issuers who wish to list a token on the exchange, to submit a document containing an independent legal analysis of the token’s potential consideration as a security in the relevant jurisdiction of the project.

The regulatory pressure that has impacted centralized exchanges, appears to be equally impacting decentralized exchanges. Recently, the IDEX CEO made it apparent that any DEX that relies even to a small degree on centralization, is subject to regulatory compliance. In a blog post released on November 1, 2018, IDEX announced the platform will now enforce KYC/AML procedures and has begun blocking traders from certain geographic regions, including NY State. NY state requires digital currency exchanges to have a bitlicense, which IDEX currently does not have.

Further, the United States SEC has even taken enforcement actions against the founder of a decentralized digital currency exchange–the first such action against a DEX. In a press release dated November 8, 2018, the SEC announced settled charges against the EtherDelta founder, Zachary Coburn, for operating an unregistered national securities exchange.

We have found that from their current state, decentralized exchanges have significant room to improve in terms of lowering fees, increasing decentralization, and offering more scalable solutions which would in the future allow DEX platforms to capture larger trading volumes. To this day, no Ethereum equivalent platform has been successfully built that would result in lower transaction/gas fees. Projects attempting to solve this include EOS, Cardano, NEO, Waves, Tezos and others–all of which have seen adoption at a fraction of the Ethereum network. Despite the challenges, truly decentralized exchanges remain an important step in constructing a robust digital asset market infrastructure and will likely continue to be explored and hopefully improved over time.

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