Forefront Communications

Coindesk: DeFi’s Good, Bad and Ugly

CrossTower

Alexandra Hamer

Alexandra Hamer

Kapil Rathi is CEO of CrossTower, a crypto exchange and structured products provider. He has held senior leadership roles at Cboe, Bats, ISE and the New York Stock Exchange.

Everyone has fallen in love with decentralized finance (DeFi). We’re all giddy about it. One subset of DeFi is the ever so popular decentralized exchange (DEX). DEXs, such as 0x, Uniswap and Kyber, have tried to compete with centralized exchanges by offering a peer-to-peer trading model, which theoretically requires no intermediaries and no deposits on a centralized exchange.

There’s one big problem: liquidity or, more specifically, a lack of liquidity. In the past, there were buyers that couldn’t find sellers and sellers that couldn’t find buyers. With a lack of liquidity, the spreads on these platforms weren’t competitive to centralized exchanges. This is precisely why centralized exchanges played a critical role bringing market makers and traders to a central limit order book.

The latest breed of DEX have solved this liquidity problem by developing “automated market making” (AMM) models where liquidity providers commit assets into a network (controlled through smart contracts) and the exchange generates bids and offers by using an automated mathematical formula. Partakers at these exchanges are able to generate potentially hefty returns by using techniques like “liquidity mining” and “yield farming.”

For my non-crypto friends, liquidity mining is analogous to rewarding market makers for providing liquidity with new tokens. Yield farming is an algorithmic way to lend assets into different pools to generate a return. “Farmers” may hop from one protocol to the next to maximize returns. Yield farmers can also be rewarded with incentives, or additional tokens.

One example of a successful decentralized exchange is Uniswap. In fact, according to recent news, Uniswap may be doing more trading volume than the largest U.S. centralized exchange. And many are citing volumes at these decentralized exchanges as the benchmark for success.

But before we make that comparison, let’s dig a little deeper into an entity like Uniswap and the “volume” on its platform. A large percentage of Uniswap volume is in coins that are spanking new and may not have a real use case. Anyone can create a token on Uniswap. Does high volume in coins like SUSHI, YAM and KIMCHI really mean Uniswap is better than other exchanges?

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