Published: April 30th, 2021
While you might think the Ethereum blockchain’s high transaction fees would be a disincentive for crypto traders, they don’t appear to be stopping them from flocking to the network’s DeFi platforms. Uniswap, a decentralised crypto exchange (DEX), posted transaction volumes last week of over USD 10 billion.
According to numbers from Uniswap Analytics, the weekly transaction volume milestone is a first. By reaching USD 10.16 billion, Uniswap rakes in a 25 per cent increase over the previous week.
Decentralised exchanges enable users to trade tokens without surrendering custody of their coins to a third party. They’re becoming a popular entry point to the exploding decentralised finance (DeFi) market, allowing people to take out loans in cryptocurrencies and earn interest on their holdings without the intervention of a traditional financial institution.
Uniswap is one of the Ethereum network’s original decentralised exchanges. Its users trade ERC20 tokens, which are a form of cryptocurrency built on the Ethereum blockchain. Other stablecoins using the Ethereum underlying technical infrastructure include USDC and Tether and DeFi protocol tokens such as Celsius and Aave.
Hot on Uniswap’s heels are DEX competitors like 1inch and SushiSwap. But the exchange also faces stiff competition from non-Ethereum DEXs such as PancakeSwap, which uses the Binance Smart Chain. Crypto traders clearly like the Uniswap service, but Ethereum-based DEX's have a problem: high fees. Traders naturally look to evade them if they can.
Statistics from BitInfo show that fees on Uniswap and other Ethereum DEX's an average of USD 20 or more. In comparison, the faster Binance Smart Chain works with Ethereum applications, but transaction fees typically amount to pennies. Others like PancakeSwap charge a fixed rate of 0.2 per cent.
That gap in cost is much too big for financially savvy traders to wave away as it cuts into gains and makes losses worse. That’s probably why PancakeSwap racked up more than USD 4 billion in volume at one point last week, while Uniswap pulled USD 1.8 billion in the same 24-hour period, according to crypto trading analytics firm CoinGecko.
So, while Uniswap can feel good about crossing the 10 billion mark, competition and the opportunity for a new low-fee option to emerge means it’s too early to declare a clear leader in the DEX space.
Uniswap executives know they need to stay competitive. The exchange’s next big update, Uniswap V3, promises improvements to both liquidity and trading efficiency. It's planned to go live next week on the 5th of May.
With the coming launch of Optimism, a solution to scale Ethereum, Uniswap V3 will launch on that platform as well. Speaking to the press in March, Uniswap founder Hayden Adams said V3 delivers ‘impressive design improvements, meaning the cost of v3 swaps on Ethereum mainnet will be lower than that seen on v2. Once Optimism has been deployed, the transactions made there are expected to be significantly less expensive in terms of fees.’
A decentralised exchange is a trading forum where traders can swap cryptocurrencies without a middleman taking custody of their holdings first. Contrast the workings of a DEX with a centralised exchange like Coinbase, where users can buy, sell or trade any cryptocurrencies listed there, but the exchange acts as a custodian on your behalf. Trades, for example, swapping Ethereum for Bitcoin, don’t happen on a blockchain; they execute within the exchange’s database.
Exchanges like Binance and Coinbase pool users’ cryptocurrencies into wallets that the exchange controls. One of the reasons people are flocking to decentralised exchanges is security. A centralised exchange could decide to arbitrarily restrict access to your crypto or limit your ability to trade it. Cybersecurity experts say centralised exchanges are also more vulnerable to hackers.
On the flip side, however, centralised exchanges are user friendly and make it easy for newcomers to get involved in crypto trading. They’re also typically faster in trade execution since they don't rely entirely on blockchain infrastructure.
Market analysts say this is one reason why Coinbase has been able to make itself the go-to brand in America for the crypto-curious. You can dip a toe into crypto with just a few dollars and not have to submit to complicated processes or learn a lot of technical lingo.
For those lite-volume, have-a-go users, allowing Coinbase to be their crypto custodian is probably just fine. For more sophisticated traders dealing in larger amounts, the lack of control over their virtual currencies is likely more worrying.
A decentralised exchange relies on automatically executed protocols called 'smart contracts to enable crypto trades between individuals without taking custody of their coins.
This is typically handled in one of three ways: through an off-chain order book, an on-chain order book, or by creating an automated market maker.
With an on-chain order book, the details of each transaction are written onto a blockchain, from the purchase to the initial request to purchase or cancel an order. Some would argue that's precisely the benefit that blockchain decentralisation is meant to deliver. However, on the downside, the requirement to record everything can slow down transactions and make them more expensive.
Off-chain order books capture information in a database to save time and only use the blockchain to settle the transaction. However, the fact that orders aren't stored on-chain means this approach can raise some of the same security issues as using a centralised exchange.
Automated market makers (AMMs) do away with order books entirely by removing counter-parties from the equation and replacing them with algorithms. Software sets the price, meaning you can trade one crypto for another regardless of whether there’s a human on the other side of the trade. AMM’s rely on liquidity pools, which they create by paying users to keep some of their funds in a smart contract so that the pool can be tapped for trades.