Is markets for the long-tail of coins significant enough?
|Aug 5||Public post|| 3|
One of the clearest uses for blockchains is permissionless, non-custodial exchange of assets. The most common way to achieve this use is through “decentralized exchange” or “DEX.” While there are many working implementations of DEX, usage remains insignificant compared to the many centralized exchanges (Binance alone does roughly 1000x the volume of four leading DEXs–Uniswap, Kyber, 0x, DutchX–combined). What gives? If DEX is the future, why don’t the numbers look better?
My hypothesis is that the market for DEX is actually much smaller than DEX bulls think. Where DEX really shines is in offering the long-tail of markets for digital assets. Everywhere else, most people will prefer centralized exchange.
The long-tail of markets are either coins or markets unsupported by centralized exchanges.
Unsupported coins are either too small, too risky, or too competitive for an exchange to support. Small would be any coin with volumes lower than a certain threshold, risky would be any coin with high regulatory uncertainty, and competitive would be like an exchange coin from a different exchange.
An example that sort of satisfies all three is LEO. The only major exchange supporting LEO is Bitfinex, the issuer of the coin. Volumes are low, US users are not allowed to buy it, and Bitfinex is competitive with other exchanges. To acquire LEO, US investors either needed to buy OTC or use a DEX.
Unsupported markets are either new trading pairs (e.g. ETH pairs) or new contexts to trade (e.g. a trading widget within a game or application). These are substantially less significant than unsupported coins but could grow in importance over time.
DEX offers something distinctive to speculators: more assets and more markets. By definition, they are not competing with the major exchanges. Upstart centralized exchanges may try to compete on the long-tail of assets and markets, but they’re at a disadvantage. Traders are more likely to want the safety of non-custodial trading faced with the alternative of trading on an untrusted centralized exchange.
So the future success of DEX is tied to the future success of long-tail markets for digital assets. If you imagine a future dominated by bitcoin, where utility tokens have little use, then DEX doesn’t matter. But if you imagine a future with millions of tokens used for all sorts of little things that lots of people use, DEX is pretty compelling even if it’s just limited to the long-tail markets I’ve described.
And we cannot completely write-off the possibility that DEX becomes the default. Things could shift towards DEX if:
If pooled liquidity in DEX exceeds liquidity on centralized exchanges
Regulatory pressure forces centralized exchanges to migrate to DEX (watch Binance here)
Innovation outside of DEX creates huge crypto-native userbases on e.g. web3 apps where DEX is convenient to implement as widgets in games and applications
To zoom out a bit, the most common arguments I hear for DEX are (in order or frequency):
Non-custodial (reduces risk from hacks, exit scams)
Permissionless, anonymous (affords a tool for secretly trading ==> avoiding taxes, enabling capital flight)
I’d wager this list should be flipped. More markets is the most important, followed by tool for capital flight, and finally non-custodial as something that probably very few people care about.
I think many will disagree here. Curious for your thoughts. Are DEX the future? Why?