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Bitcoin’s long bull run and the recent wave of corporate and institutional investors allocating significant portions of their reserves to Bitcoin (BTC) are all signs that the pace of cryptocurrency mainstreaming is rapidly accelerating – but the path to adopting mass has had a cost of privacy and decentralization?
Know your customer and anti-money laundering laws have forced most cryptocurrency exchanges to become more transparent about who their users are, and those who have declined have had to limit the jurisdictions in which they can offer services.
To operate legally in many countries, many exchanges had no choice but to stick to strict anti-money laundering procedures, and aside from Monero (XMR), a number of privacy coins have been removed from most major exchanges.
Recently, regulators have begun to suck, and jurisdictions around the world continue to roll out additional measures to ensure that investors disclose their crypto holdings and pay taxes on their profits.
And all of this is happening when the US Department of Justice arrested the co-founder of BitMEX and the CFTC accused its owners of running an illegal cryptocurrency exchange.
About a week later, the Financial Conduct Authority, the UK’s leading regulatory watchdog, went so far as to ban investors from trading derivatives across all cryptocurrency exchanges.
All of these maneuvers are designed to enforce compliance on cryptographic service providers, and while they may ultimately help promote mass adoption, many crypto ideologues are looking for alternatives to back up their reasons for financial self-sovereignty.
Decentralized exchanges can be the solution
A growing number of investors believe that centralized cryptocurrency exchanges function essentially the same way as traditional banks. In response, decentralized exchanges such as Uniswap, 1inch, Curve Finance, and Balancer have grown in popularity over the course of 2020.
For more sophisticated investors, decentralized exchanges offering derivatives trading have also become available. Similar to traditional derivatives, the crypto exchanges that offer the service essentially act as a broker, but the process is slightly different on decentralized exchanges. This is because they use smart contracts instead of a broker, and derivative contracts are settled when the terms of the contract have been met.
At the moment, Synthetix is one of the most popular decentralized derivatives exchanges and in 2020 saw its total frozen value rise to $ 1 billion before a sharp sector-wide correction led to a drop in TVL and daily active users. in most DEXs.
The exchange allows users to create a tool called a synthetic asset “Synth” that can track gold, fiat and cryptocurrencies. It also allows the creation of assets that follow the price of the assets in reverse.
Users of the platform can also stake the native SNX token as a guarantee for minting new synths, and similar to Uniswap, liquidity providers are rewarded by earning a portion of the exchange’s transaction fees.
Those familiar with DEXs like Uniswap will know that literally anyone can list a new asset, which, in the case of derivatives, means that any underlying asset can be turned into a derivative.
These platforms allow users to trade derivatives without the need to deposit funds into any centralized platform and are not required to complete any KYC procedures.
While some investors shy away from KYC and tax compliance, this is serious business for cryptographic service providers. According to Molly Wintermute, an anonymous developer credited with founding Hegic DEX, compliance is more of an issue for centralized cryptographic service providers, not DEXs.
When asked how DEXs can remain compliant with financial regulators, Wintermute bluntly explained in one language that:
“They can not. this is a new level of financial infrastructure, not an addition 2 z current financial system. it’s like TCP / IP or FTP, not just a decentralized crypto exchange. You can’t stop the code or ban the Internet. unless the public blockchain is open and permissionless it is next to impossible 2 to ban decentralized derivative protocols. “
Wintermute further explained that decentralized derivatives attract a particular subset of investors because:
“Non-custodial trading (protocol / people don’t hold funds like allocated funds on smart contracts). Verified Chain Settlement (Cannot manipulate 2 low cost derivatives and close origin trading algorithms that only exchange owners know how they work / manipulate 2). deeper liquidity (the new peer-to-pool / peer-to-contract model could offer lower spreads and better conditions 4 users). “
According to Wintermute, the number of investors actually using DEX is quite small, compared to the total number of crypto investors. For Wintermute, this means that the ban on FCA derivatives and the recent legal actions taken against BitMEX are completely irrelevant and not applicable to decentralized finance protocols.
Wintermute said:
“The decentralized derivative is part of the small crypto world. There are over 100 million holders of cryptocurrencies globally. About 5-10 of them could actively trade crypto derivatives (globally). I don’t think FCA’s ban. has opened up exciting new opportunities. nothing has changed. “
After being pressured to investigate the possibility that the SEC, FCA or other regulators might not attempt to shut down a platform like Uniswap and arrest its founders, Wintermute said:
“They could probably arrest 1 or 2 CEOs like the founders of bitmex who have some shady things going on internally, but only 2 make everyone else feel fear. They can’t arrest everyone. Also compare decentralized derivatives to used cryptocurrencies. 4 that sell drugs. These two things come from different sides of a spectrum. A toy in the case of decentralized derivatives and a gun in the case of dealers who use cryptocurrencies. Decentralized derivatives are not a crime. “
Wintermute also seemed to shake off the recent BitMEX scandal, replying abruptly that:
“I don’t think anyone cares about DeFi or DEX. The guys at bitmex have so many dark things inside that this could be a great target 2 attack while the DeFi / DEX protocols have 100% transparency and you can’t take a 2 person in jail 4 to create a website that only has numbers about it being transparent 4 all the others in the world z. “
Ultimately, Wintermute believes that “Bakkt / CME and other s — guys are so mad no one uses their products that they now take the crypto entrepreneurs and try to send them 2 to jail.”
The anonymous developer then explained that, in his view, the “meta game is 2 to ban all cool crypto products and try 2 to cannibalize them on their user base but with s —– compliant products.”
While some of Wintermute’s bold claims may be deserving, the arm of the law is quite long and, as we’ve seen with the now defunct era of the ICO, bringing in those who violate securities laws takes time.
In 2020, the total value locked in DeFi platforms jumped to $ 12.6 billion, and data from Dune Analytics shows that Uniswap processed a volume of $ 11.2 billion in October. These huge figures are sure to attract the attention of US and international regulators, so it may only be a matter of time before legal action is taken against DEXs.
Decentralized exchanges are a test bed for tier two solutions
In addition to addressing privacy concerns and restoring decentralization in the crypto sector, DEXs also provide a sandbox for level two developers to play in. As Cointelegraph reported extensively, scaling within the Ethereum network has been a persistent challenge.
When the grid becomes congested during periods of high demand, gas rates rise exponentially and the speed of transactions stops. With Ethereum 2.0 in perceptual “development”, a number of DEXs have begun experimenting with the integration of tier two solutions to provide users who are willing to give up the Ethereum network with cheaper and faster options.
Project Serum is probably one of the best known success stories for a non-Ethereum based DEX.
The decentralized derivatives-based project is built on the Solana blockchain instead of the default Ethereum network that most DEXs operate on, but is also fully interoperable with ERC-20 and Bitcoin-based assets.
FTX CEO Sam Bankman-Fried and his team are the brains behind Project Serum, and according to Bankman-Fried, the project is designed to bypass the privacy and security concerns of centralized exchanges by providing users with a permissionless method to invest with leverage and trade assets.
The project also provides a cheaper alternative to the high gas tariffs and low transaction speeds that often plague the Ethereum network during periods of high traffic.
Bankman-Fried said:
“To build a product that can deliver fast and cost-effective order matching, you need a chain with a high yield. This demand increases further for non-standard market trading and risk management or liquidation. Serum chose to build on Solana because the chain focused on a unique and powerful vision for scaling. “
According to Bankman-Fried, technical problems like congestion and high fees can make or break an investor. As for the high fees, he said:
“They are fatal: you basically cannot have derivatives on Ethereum due to scaling issues. To the extent that decentralized derivatives have growth opportunities, they will be on a new L1 or L2.”
Bankman-Fried also agreed with Wintermute’s claim that hardly anyone uses DEXs, as “the vast majority of derivatives volume is on centralized exchanges”, but suggested that in theory, “composability and self -custody “should be incentives for more users to join the movement.
One DEX to rule them all
Currently, investors have shifted their focus back to Bitcoin as the digital asset pursues a new all-time high and data from Cointelegraph and Digital Assets Data indicates that DEX trading volume and daily active users continue to decline.
While this is likely disappointing for investors, it at least gives developers some quiet time to focus on properly integrating layer two solutions to DeFi protocols.
The trend of major cryptocurrency exchanges to become more centralized is unlikely to change anytime soon. This means that the first DEX to successfully deliver a platform with low fees, privacy protection and a fast, user-friendly interface will reign supreme once investors make the choice again to invest in decentralized finance and decentralized derivatives. .
