By Palash Udhwani
FTX group’s various entities going down in a recent turn of events was a big blow to retail, institutional, private equity, and market trust in emerging tech like blockchain. While the platforms were facilitating trading and movement of digital assets and tokens that are programmed to be decentralized, such a big point of failure was inevitable to provide the features that FTX aimed for. So, the big battle in all crypto exchanges has been about the level of decentralization and trust you can put in them and the amount you’re ready to pay. A good alternative with the highest decentralization to achieve the same goals was DEX’ (Decentralized Exchange). But how they fare against centralized exchanges and how they react to such scenarios is what we’ll discuss here.
During the entire FTX fiasco, multiple halts to the withdrawal of funds were recurring under FTX’s or SBF’s control. This is the biggest issue that DEXes solves. While interacting with a DEX, you use a wallet whose private keys or, for a more straightforward understanding, the master keys reside with you. But in the case of FTX, these keys were with FTX. At the same time, this risk could have been slightly negated if FTX had implemented a proof of reserve since day one or had its audit done in a different / stricter jurisdiction. It would have kept a check on the team’s actions, keeping an oversight on the customer funds’ security. But that’s what blockchain strives to solve. When you trade on a DEX, as opposed to FTX, you’re trusting on-chain code that can’t be changed suddenly (Auditing of the contract still applies) and a network of blockchain nodes storing every movement and transaction happening. These two are significant differentiators, as these are two major points where FTX’s action went wrong. Reports of a backdoor being involved in FTX’s system to manipulate funds without any public signal on-chain was a significant contributor to such a big movement of customer funds being repurposed unethically for different agendas than they were meant for. And when you’re trusting on-chain codes to execute your trade, you aren’t at the behest of a small group of people who can monitor your trades and have the power to stop anything anytime. While DEXs have challenges, self-custody and security of funds is the problem that DEXs address.
These two statements were among the strongest for customer fund protection and got mentioned in FTX’s terms service.
Unfortunately, breaking these too exact rules is what started the whole fiasco.
DEX provides better custody with uninterrupted executions. Centralized alternatives face slowdown less often, as they are highly efficient in scale, providing much better fees as compared to the decentralized alternative due to the better optimization. Both kinds of exchanges have their benefits and issues to solve on different fronts. We have seen massive outflows from centralized exchanges in the week following FTX’s insolvency rumors.
Although trading fees on DEX are higher, the security and trust are higher than on centralized options. Times like these are when the usage and volume on DEX shoot up, and the exact causes demand the block space or the transaction to execute on the chain to rise. The gas fees on-chain are very dynamic, and the total fees in such time and costs for each transaction increases by multifold.
There was a sudden spike in volume and the number of weekly trades on DEX. While spikes denoted an overall picture of the DEX system, a good and consistent performer in the space with unique features under its belt and an agile team behind it is dYdX.
DYdX platform is a “hybrid” decentralized exchange, meaning that most of its operations are handled by code rather than a centralized intermediary. The platform is the most extensive decentralized finance (Defi) exchange by 24-hour trading volume and has processed $3 billion in transactions over the past 24 hours.
DYdX was hosted on Ethereum until August 2020. It was a significant issue because Ethereum’s gas fees are volatile and rise as network activity increases. dYdX has switched to the StarkWare Layer 2 network, which has increased transaction volume and decreased transfer fees, to solve the scalability issue. Starware is an excellent example of the continuous innovation happening in space.
The protocol makes revenue from fees as a percentage of each trade. Due to the high volume of BTC and ETH trades, it is also the protocol’s highest source of fee income. On November 8th and 9th, 2022, during the FTX unwelcome events, fee revenues went up to $880k.
While the recent issues in the space have created a lot of short-term and long-term behavioral changes and reassessment of risk for investors, this isn’t only a one-time thing that DEX’es like dYdX have shined much better. Last year in September, China declared an outright ban on holding, trading, or any activity related to cryptocurrencies. Hence, subsequently, centralized exchanges of any kind had to shut down. But the CEX (Centralized Exchange) loss was dYdX’s gain, and the revenue for the same shot up from 600k at the month’s start to 6.8 million by September end or about 5.6x in just the last week.
A recent outperformer in the space and a trader’s favorite is GMX. GMX is a decentralized spot and perpetual exchange with low swap fees and trades that do not affect the price. A unique multi-asset pool backs up trading. Market making, swap fees, and leverage trading all pay fees to liquidity providers. Chainlink Oracles and a collection of prices from the top volume exchanges are used to support dynamic pricing.
GMX is in the top 5 list now, and more people are paying higher fees to use the protocol. It was on the number 7 spot on November 1, which has now jumped to the 4th spot alongside its revenue.
There was a spike in 1-day fees to $1.5 Million during the FTX news. But now it’s returning to an average value of $450k. The GMX stakers and GLP liquidity providers get all fees from swaps and leverage trading.
However, the team’s anonymity worries the GMX project because it is impossible to evaluate the team members’ credibility using established criteria like credentials and experience. The team’s capacity to deliver features and products should be assessed as a backup plan.
Since it was announced that FTX group(with some minor exclusions) would voluntarily file for chapter 11 bankruptcy, FTT was the top-losing and trending cryptocurrency for that day. The FTT token’s value dropped from around $22 on November 7 to $1.98 due to unfavorable developments at FTX. The value of DEX tokens like dYdX and GMX outperformed the whole crypto market and BTC in the same time frame.
It shows that DEX’es have effectively experienced and managed high demand in times of certainty. While each DEX is trying to figure out its strategy around protocol fees, revenue, and network congestion, the key benefit here is the custody and security that comes with it. While this risk can be solved with centralized exchanges to some extent, enforcing regulations around proof of reserve and continuous audit of customer funds safety is crucial and essential for the space. It will facilitate growth post all the distrust that emerged from recent brash behavior by organizations with no oversight or clear on-chain depiction of their actions.
The regulatory worries surrounding CEX trading are making it clear that a fully decentralized DEX is required for both spot swaps and perpetual futures.
The author is investment analyst, Kunji