• Commentary
  • August 22, 2020

Over recent months, volumes across decentralized exchanges have surged, while Uniswap has progressively increased its market dominance. This dispatch examines Uniswap’s offering as well as the future of DEXs more broadly.

Despite prevailing mainstream narratives within the blockchain ecosystem over recent years expressing doubts about the potential adoption of decentralized exchanges (DEXs)— over the past several months, the rapid growth of DEX volumes has increasingly undermined this thesis. While DEX volumes grew consistently 2019-2020, from $39,548,000 to $486,442,000, the past three months, in particular, have witnessed monumental increases: from $1,615,689,000 in June to $5,948,133,000 in just the first 20 days of August. Such growth accompanies not dissimilar growth and attention within the broader decentralized finance (DeFi) sector.

Monthly DEX VolumeMonthlyDEXVolume.png

Source: Dune Analytics

Uniswap, which has increased its market share, in terms of volumes, from 15.7% at the beginning of March this year to 57.6% as of August 10th, increasingly dominates other DEXs in adoption. Meanwhile, Curve, a stablecoin-focused DEX, also increased its share from 7.6% to 18.6% in the same period, with the two venues now collectively accounting for 76.2% of the market. The current DEX market, despite its ambitions concerning decentralized and censorship-resistance, is starkly more concentrated than it was just a few months ago.

This concentration raises concerns about the ramifications of technical, economic, or regulatory affronts on the two protocols across the entire DeFi space. Indeed, this trend may continue to develop. Unlike centralized exchanges, where regulatory approval is necessary to operate at scale and requires intense efforts on a per-nation basis, DEXs face no such burden (at least for now) nor are they reliant on local infrastructure and networks for their success. These differences may, in turn, maintain and even increase the current concentration among DEXs relative to their centralized counterparts.

Several reasons have been postulated to explain Uniswap’s success. While Smith + Crown is not entirely satisfied with the prevailing explanations, we do agree with many, namely that the protocol’s focus on an intuitive frontend and user experience has been a key contributor, in contrast with many DEXs that neglect this important component. Beyond this, the lack of KYC requirements, use of a pooled automated liquidity model, competitive fee structure for end-users and liquidity providers, and continued product development, with the introduction of features such as flash loans, improved oracles, and ERC20-ERC20 pairs have all likely helped the protocol grow at the rate it has. Importantly, the network effects of any exchange venue can be particularly strong, due to the pull effect of liquidity, and are even more pronounced with DEXs for the reasons so far mentioned, resulting in a reinforcing loop between increased use and liquidity, a difficult burden for any competitor to overcome. Conversely, the decreasing market share of other DEXs, such as IDEX and Loopring, present case studies as to what deters adoption, including the enforcement of KYC, the use of an order book model and poor UI in the case of IDEX and in the case of Loopring, an order book model combined with the net negative tradeoff between scaling on layer two, via zkRollup in Loopring’s case, and composability on layer one.

With Uniswap having recently announced an $11M Series A fundraising round, there has been speculation around the introduction by the team of a protocol token, that would extract fees in some manner, beyond the recently introduced but dormant 0.05% protocol fee. With the protocol currently generating $124.1 million in annualized revenue, currently paid to liquidity pool owners, any new token that captures just a share of this amount, is likely to be one of the most sought after tokens in the whole cryptoasset industry, for its ability to generate potentially lucrative dividends for prospective holders. As such, Uniswap would be almost unique among DeFi tokens, in its ability to provide cash flows to holders out the gate, without any use of liquidity mining or other mechanics to generate protocol usage.