If you are a blockchain enthusiast, you must have heard a lot about decentralized exchanges. If you are wondering whether DeFi has the potential to replace the entire concept of centralized finance, CeFi and if it can meet the growing demands, you are at the right place. So Let’s get started.
Table of Contents
- Understanding DeFi- A to Z of DeFi
- Can DeFi Compete with Centralized Exchanges- Issues to Consider
- Trending DeFi Platforms You Should Know
- Concluding Lines
Understanding DeFi- A to Z of DeFi
Decentralized exchange, also known as DeX, is an ecosystem that utilizes decentralized networks to remodel existing financial products into a transparent protocol without involving any middleman. DeFi offers an open finance platform that aims to modify and reconstruct all the financial services such as lending, borrowing, and trading under complete decentralization. DeFi enables users to manage their assets on their own through P2P and dApps, without relying on any third-party like a traditional cryptocurrency exchange. This ecosystem is gaining people’s attention due to its open-source, permissionless, and transparent financial services available, which is available to everyone having internet connection.
In simpler words, we can say that DEX is just like a stock exchange run by a smart contract, especially on the Ethereum blockchain.
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Can DeFi Compete with Centralized Exchanges- Issues to Consider
The decision to utilize and expand decentralized exchange was to implement full on-chain transparency and to allow complete trustless participation among participating partners. The DeFi space is governed by automated market makers (AMMs) whose first implementation was Bancor, followed by other similar systems such as Balance, Uniswap, Mooniswap, etc.
Head of business development at layer-two DEX Loopring Matthew Finestone states that AMMs “have product-market fit, but he also believes that the DEX’s existing issues could restrict the market’s size.
Paolo Ardoino chief technology officer at crypto exchange Bitfinex believes that on-chain settlement could never compete with CeFi.
In his words, “The current solution for decentralized exchanges, even if Ethereum grows and becomes Ethereum 2.0 and the transaction speed becomes, let’s say 10,000 transactions per second, will still be many orders of magnitude slower than one single centralized exchange.”
He further explained that ‘the speed of light’ is the most significant issue with on-chain settlements. When all the nodes present in the universe have to agree on a particular single block, no networking enhancement can beat the performance given by co-locating trading infrastructure in the exchange’s data centers, and such network performance restrictions could create obstacles for high-frequency trading companies.
According to Dan Matuszewski, co-founder of trading firm CMS Holdings,
“First off, the experience sucks, in no way will you convince me it doesn’t suck, I won’t have it…My second big issue is I feel I have no idea what the terms of the transaction are until post settlement… Speed is the last issue; it’s not slow; it’s just not fast,” which shows that speed was not a major issue for Matuszewski.
Many blockchain experts believe that front-running attacks are the other significant issues that DeFi has to deal with. In front-running, miners are in the best state to carry such attacks as they hold a good control over the executing transactions and can mix in their own transactions without broadcasting them.
Talking about fixing issues, Uniswap’s founder, Hayden Adams, tweeted that the launch of smart-contract-enabled Optimistic Rollups strategies on Ethereum can help in improving the performance and throughput.
However, optimistic roll ups come with its own set of drawbacks as it could increasingly worsen the front-running issue by only letting the rollup operators (the guy who actually runs the thing) see the transactions in advance.
Trending DeFi Platforms You Should Know
Here we will not provide details about the most popular and trending DeFi platforms will just enlist a few of them.
In centralized finance, users trust the people and centralized authorities for storing and managing their funds, while in DeFi, participating parties trust the underlying technology, blockchain. Considering the pros and cons of DeFi, it is clear that decentralized exchanges have the potential to reshape the entire financial system, but it may or may not replace the existing traditional centralized systems, as it has to overcome the technical risks and operational risks associated with it.
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