If a truly fair financial system is to ever see the light of day, many signs point towards decentralization, at least to some degree. Despite the very early stage of DeFi, there are already plenty of indications pointing toward DeFi protocols eventually rendering centralized systems obsolete.
Decentralization is the Driving Force Behind Digital Assets
It is no understatement to say that the main reason why the digital asset ecosystem exists in its current form is due to Bitcoin. As we have seen from the Musk-induced crypto crash in May, when Bitcoin falls, so does the entire crypto space. More importantly, the main reason why Bitcoin gained traction in the first place is a result of its decentralized nature.
Not only is deflationary Bitcoin more accessible to obtain than gold, but one doesn’t have to entertain mediators to get it. With these key features, Bitcoin advocates suggest the asset has what it takes to become the world’s bank, but one that is not under anyone’s yoke.
Moreover, suppose in the distant future Bitcoin replaces certain aspects of the banking sector. In that case, we already know that its environmental impact would be an invisible slice compared to the current carbon footprint of the financial industry. Therefore, it is easy to see that, while blockchain technology is there to secure its decentralization, this feature alone largely drives the entire crypto space.
However, the path to this decentralized gold-like asset remains heavily centralized. It may be convenient to use crypto exchanges, but giving them the custody of your private keys defeats the purpose of DeFi. When we compare one such centralized exchange – Coinbase – with a decentralized exchange (DEX) – Uniswap – we see that other issues emerge as well.
Coinbase vs. Uniswap: Drastic Cost-Effectiveness Disparity
If there is one lesson to be learned from the GameStop saga, centralized market makers are too intertwined with brokers to be viewed as trustworthy. In May, even the US House Financial Services Committee floated the balloon to ban the practice of PFOF (Payment for Order Flow). Once again, we see that decentralization is a highly sought feature.
This is why Uniswap, after pioneering Automated Market Makers (AMMs), rose to such rapid prominence. Uniswap amassed $293 billion in all-time trading volume across 72k liquidity providers in a few short years. More tellingly, the platform achieved this with a few dozen employees. When we compare its output to Coinbase, the difference in cost-effectiveness is stark.
Coinbase’s cost of doing business seems to grow exponentially. During 2021, it had to increase its support staff by 5x, to over 3,000 personnel. Not only does a centralized exchange require far more people to run, but they themselves may end up hurting the customers. In October 2020, over 60 employees walked out because they couldn’t turn Coinbase into an aggressive, political advocacy platform.
Usually, employees walk out when the company forces them to do something outside the bounds of providing customers with the core service. This alone poses a severe centralized vulnerability. Coinbase may become akin to a crypto PayPal if that trend continues, restricting service based on arbitrary reasons. In all fairness, this is entirely speculative however.
Then, there is the final burden of using centralized exchanges – offloading business costs to customers. The Tokenist recently reported on Coinbase’s fee structure, and the result is as you would expect. Coinbase charges the highest trading fees among US crypto exchanges, forming 94% of its income, translating to $771 net profits in Q1 2021 alone.
Are Atomic Swaps and DAOs the Final Nails in Centralized Crypto Exchange Coffins?
While trading with Bitcoin on Uniswap is currently delegated to its synthetic version – Wrapped Bitcoin (wBTC) – the emergence of atomic swaps should remove that limitation. Atomic swaps represent the cutting edge of cryptography in the form of smart contracts . This makes it possible to exchange crypto assets residing on isolated blockchains, as is the case with Bitcoin vs. Ethereum.
Moreover, the DeFi space has another trick up its sleeve to make exponential growth of support personnel obsolete – Decentralized Autonomous Organizations (DAOs). The Wyoming Secretary of State recently announced the legal recognition of the American CryptoFed DAO. This DAO uses a governance token – Locke – to stabilize its Ducat stablecoin, thus creating a tokenomic system in which both inflationary and deflationary forces are kept in check.
Governance tokens within DAOs represent direct voting power alongside being used to pay for transaction fees. In the case of Uniswap, this is the UNI token. Other DEXes give users even more power to control the direction of the platform. For instance, 1INCH stakeholders can vote on price impact fees, swap fees, token decay periods, referral rewards, and even on governance rewards themselves.
These decentralized mechanisms provide a more robust and scalable framework instead of relying on the whims of a centralized exchange’s support staff.
Lastly, when it comes to project launches, it is much easier to venture into the DeFi field than to amass the funding necessary for centralized systems. For instance, 1inch Network, as a DEX aggregator, was initially developed during a hackathon event within a 3-day period.
While venture capitalists did step in later to fund the project, its current market cap of $419.5 million speaks to the fact that one doesn’t need large initial capital to launch a DeFi startup.
Do you think atomic swaps will upend the current crypto space, putting a focus on privacy assets like Monero instead of pseudonymous assets such as Bitcoin? Let us know in the comments below.
About the author
Tim Fries is the cofounder of The Tokenist. He has a B. Sc. in Mechanical Engineering from the University of Michigan, and an MBA from the University of Chicago Booth School of Business. Tim served as a Senior Associate on the investment team at RW Baird’s US Private Equity division, and is also the co-founder of Protective Technologies Capital, an investment firms specializing in sensing, protection and control solutions.
