Reviewing the Biggest DEXes in a Constantly Evolving Crypto Marketplace
VYSYN Weekly Release #92: Centralized exchanges in line for severe disruption
Centralized exchanges (CEXes) appear to work perfectly for traders until they don't. Hacks, censorship, and other major concerns make CEXes risky for traders seeking anonymity in the digital asset markets. A recently released Netflix documentary – Trust No One – highlighted the tail end of the risks with CEXes as it detailed the story of QuadrigaCX users completely losing their funds after the alleged death of the founder.
However, the introduction of smart contracts and other complex DeFi products has led to the creation of an innovative solution. An exchange that operates in a completely decentralized and trustless manner, without a single point of failure — a decentralized exchange (DEX).
In the latest edition of the VYSYN Release, we analyze what DEXes are and how they work. We will also highlight some of the biggest DEXes in the market and how they add value to the digital asset industry.
A permissionless exchange built entirely on smart contracts
Exchanges have played the role of matching buyers to sellers both in traditional finance and digital asset markets. Traditionally, centralized exchanges have dominated the market. However, these exchanges are failing to keep up with the rapidly developing DeFi space.
DEXes are peer-to-peer marketplaces that coordinate large-scale digital asset trading without any intermediaries. Users conduct transactions directly without handing over their funds to a custodian. These transactions are executed on-chain via the use of smart contracts.
Decentralized exchanges provide users with a level of privacy and censorship resistance that is not obtainable with CEXes. Users do not have to go through KYC and AML procedures. DEXes also prevent security risks since they do not hold user funds. As a result, network breaches do not expose user assets and personal information unlike CEXes.
Currently, the biggest decentralized exchanges in the market are beginning to challenge some of the world's largest CEXes in terms of trading volumes. Let's consider three of the leading DEXes in the market.
The top decentralized exchanges in the market
UniSwap is an Ethereum-based automated liquidity protocol that allows users to trade without any intermediaries. Since the protocol is decentralized, it has no listing process. Any ERC-20 token can be on UniSwap as long as there is a liquidity pool available for traders. Unlike most exchanges, Uniswap does not charge any listing fees.
The protocol dumps the traditional order book mechanism and acts as an Automated Market Maker (AMM.) These are smart contracts that hold liquidity reserves that traders can place orders against. Reserves are funded by liquidity providers who deposit an equivalent value of two tokens in the pool. When traders use the tokens, they pay fees to the pool that are subsequently distributed to liquidity providers based on their contributions.
UniSwap works with a unique variant of the AMM model known as the Constant Product Market Maker (CPMM). With this AMM model, rather than matching buyers and sellers to determine prices and execute trades, the prices of tokens on the UniSwap platform are determined by a constant equation x * y = k. In this equation, x and y represent the quantity of ETH and ERC-20 tokens available in a liquidity pool while k is a constant value that creates a price balance.
For instance, when a trader buys ETH tokens from the liquidity pool, the other ERC-20 token's supply increases. This automatically increases the price of ETH in the pool because the total liquidity must remain constant. Therefore, the protocol balances the value of tokens and swaps them based on the level of demand and supply.
UniSwap V2 provided several new features that improve trading, including price oracles, flash swaps, and more. UniSwap V3, which is the latest version features greater capital efficiency for liquidity providers, better execution for traders, and enhanced infrastructure.
The protocol's native token, UNI, functions as its governance token, giving holders the power to vote on certain decisions that can shape the future of the protocol. It has a total supply of 1 billion, of which 60% will be distributed to community members via liquidity mining and 40% to the team, investors, and advisors. UNI is trading at $10.89 with a market cap of over $7.5 billion. According to data from DeFi Llama, UniSwap currently has a TVL of over $7.9 billion.
(Source: DeFi Llama)
1inch is an aggregator that scans multiple DEXes to find the cheapest prices and reroutes users’ trades to them, offering better rates than individual exchanges. The DEX aggregator reduces risks of slippage, a situation where insufficient trading volume results in purchasing an asset for more than was originally intended or selling an asset for less than was originally intended. By aggregating liquidity across different DEXes in the market, 1inch increases liquidity on these platforms, counteracting order slippage.
When traders wish to buy a token via the 1inch protocol, its algorithm searches for the cheapest price. The process might involve swapping tokens between multiple protocols and for different currencies before arriving at the desired token. 1inch integrates the Pathfinder algorithm, which gives it access to over 70 liquidity sources on Ethereum, 40 on BSC, 20 on Polygon, and many more.
The protocol's native token, 1INCH, serves as a governance token, allowing holders to vote on decisions regarding the 1inch ecosystem. Users earn tokens by providing liquidity to the protocol. The 1INCH token is currently trading at $1.77 with a market cap of over $729 million.
While the bulk of DEXes has been concentrated in the Ethereum blockchain, PancakeSwap is based on the Binance Smart Chain (BSC) network. It is a decentralized exchange for swapping BEP-20 tokens and has a few similarities with UniSwap.
Like several other DEXes, PancakeSwap operates on the AMM system, which relies on liquidity pools created by users to enable trades. This means there is no order book where users are matched with someone else to swap tokens, rather liquidity providers lock their tokens into a liquidity pool via smart contracts. Traders can place orders against the liquidity pool and users who keep their coins in the pool earn rewards.
The protocol also allows users to farm its native token, CAKE. On the farm, users lock up their liquidity provider (LP) tokens to earn CAKE. They can earn even more by staking the CAKE on the DEX's SYRUP pool. CAKE is the protocol's BEP-20 governance token that is used to incentivize liquidity providers and allows holders to vote on changes in the ecosystem. The token is currently trading at $9.31 with a market cap of over $2.6 billion. The protocol has more than $5 billion in TVL.
(Source: DeFi Llama)
DEXes add value to the crypto economy
Despite being innovative solutions that traders leverage to execute transactions quickly, there are a few issues that users face with decentralized exchanges. For one thing, these DEXes are run by smart contracts that are publicly available and can be reviewed by anyone. Most reputable DEXes even hire high-profile auditing firms to audit their code and fix vulnerabilities. But, exploitable bugs sometimes manage to slip past the audits and expose the exchange to breaches. Additionally, as the industry is evolving, bad players find new ways to exploit their unsuspecting victims. Thus, the auditors might not predict potential new exploits that could cost the exchange losses.
Another issue is the complexity of operations on DEXes. To utilize these exchanges, users must know how to connect wallets that can interact with smart contracts. They must also understand several other security concepts to keep their funds safe since they maintain sole custody of their assets. Without having specific knowledge of these concepts, many things could go wrong. Sending or withdrawing funds to the wrong network, overpaying network fees, sending the wrong tokens, and many more are some of the mistakes users can make while trading, which can result in loss of funds.
Despite all of this, DEXes are introducing features that are not present on centralized exchanges. As the DeFi space evolves, these protocols evolve with it, introducing innovative solutions that were not possible before. DEXes allow users to borrow funds to leverage their positions, lend funds to earn passive income and provide liquidity to earn trading fees. These protocols have come a long way since the first DEXes appeared and their evolution is not showing signs of stopping anytime soon.
About VYSYN Ventures
VYSYN Ventures is a longstanding venture capital company that specializes in funding and supporting disruptive startups in the blockchain and cryptocurrency industry. We have provided early-stage support to several projects that have grown USD market capitalizations of hundreds of millions and even billions. Our incubation program focuses on providing capital allocation, versatile marketing support, and tech assistance.