DEXs could see demand boost as regulators target centralized exchanges

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Over the past 10 years, Bitcoin (BTC) has done exceptionally well as a store of value and for speculative investment purposes. Much of this, however, is due to its decentralized nature, which could result in regulators and governments around the world trying to shut it down long before it was even operational.

Governments are clearly concerned about the potential impact of digital assets on economies. While lawmakers are unlikely to find ways to permanently shut down decentralized networks, they can block access to the centralized platforms that interact with digital assets.

Recently, the leading global cryptocurrency exchange, Binance, has been under attack by regulators around the world, with several countries issuing warnings or announcing investigations into its activities. Currently, the centralized exchanges (CEX) seem more willing than ever to work with regulators, which could eventually affect the decentralized exchanges (DEX).

The blockchain and cryptocurrency industry has relied on an ethos of decentralization for over a decade, and with the aim of removing as many centralized intermediaries as possible, CEXs may reluctantly be the next to move volume to DEXs.

Distribute control

Although investors are sometimes offered access to a wide range of assets shortly after launch, centralized exchanges require traders to abandon custody of their investments – something that is not overly valued in the field. Although decentralized exchanges (DEXs) have been around for some time, it was only in the last year that they began to pose a real threat to their centralized counterparts.

More regulatory scrutiny is a double-edged sword. On the one hand, new users who were previously cautious about the unclear regulatory environment surrounding stock exchanges would now be more willing to enter the industry. On the other hand, however, it could be argued that due to tightened regulations, some users are leaving CEXs and choosing to move their business to DEXs

“More regulation automatically means more users,” said Jack Tao, CEO of the Singapore-based global cryptocurrency exchange Phemex. “The government has a responsibility to protect every investor, and increased regulation of centralized exchanges will raise the barrier to entry for new CEX platforms.”

He also mentioned that while stronger regulation could reduce the number of Initial Coin Offerings (ICOs) listed on exchanges, it could improve the quality of projects in this area. If properly enforced, regulation could have a more positive impact on the market than expected. Tao added:

“Central platforms still have many services to offer. A DEX is just a product with no “service” and I don’t think they will take over the centralized exchange in the short term. “

From the automated market maker-based (AMM) -based exchanges like Uniswap and SushiSwap on Ethereum, where the order book is replaced by pools of liquidity, to the order book-based serum on the Solana blockchain, decentralized exchanges offer an alternative way to trade, including the ability to earn rewards for providing liquidity. Decentralized financing (DeFi) relies on crowdsourcing liquidity, and as centralized exchanges become more in the crosshairs of governments, demand for DEXs increases.

Recently, the senior management of one of the world’s largest Bitcoin derivatives exchanges, BitMEX, received charges of allegedly lax anti-money laundering (AML) and know-your-customer (KYC) security protocols. This caused a stir, raised fears of a lawsuit against the exchange and caused the exchange’s wallets to drop to their lowest level since November 2018.

Uniswap alone has a market capitalization of nearly $ 27 billion at the time of publication, which translates into a daily trading volume of over $ 1.4 billion. Hundreds of billions of dollars flow into DEXs every month, with Uniswap surpassing the trading volume of American crypto exchange giant Coinbase last October.

Are decentralized exchanges finally giving CEXs a run for their money? With the growing regulatory concerns surrounding centralized exchanges, the demand for trustworthy cryptocurrency exchanges may have room for growth.

Exchange systems

The main advantage of decentralized exchanges is that they do not require a trusted intermediary to conduct business. However, this brings various benefits to merchants such as lower transaction fees due to lower overhead costs. With traders constantly looking for the best deal, centralized exchanges may need to lower their fees in order to be competitive.

DEXs also offer reduced counterparty risk as orders are filed against a smart contract rather than someone else, and this also reduces the surface area for malicious actors trying to siphon off funds. Decentralized finance and, in a broader sense, decentralized stock exchanges have also improved access to digital assets and given anyone with an internet-enabled smartphone access to financial services.

Several centralized exchanges are prevented from serving people in certain jurisdictions due to regulatory issues. DEXs do not have these restrictions, which allows them to enter markets that were previously inaccessible to centralized trading platforms. You are also not obliged to pass on information to third parties, with limited registration requirements for using the exchange platform.

Since DEXs don’t handle fiat currencies, they can get away with a lot more than just centralized exchanges, but there’s a very good chance that regulators won’t sit on the sidelines and watch the show. After all, you can come for them too.

DEXs are still in the very early stages and until more research is done to mitigate the risks they pose, there will likely still be centralized exchanges of some form or another. After all, CEXs offer some advantages that cannot be implemented in a decentralized manner – for example insurance.

While DEXs may be a different beast to hack, funds lost to attacks on centralized exchanges are often returned to investors, creating a sense of accountability to one of the riskiest investment markets in the world. They also offer features like customer support, fiat entrances and exits, and more liquidity in general.

That’s not to say that decentralized exchanges won’t continue to eat up their market share, and while there will always be a need for centralized exchanges, the industry may be on the cusp of a move to crypto trading with no middlemen.

The future of exchange

Ethereum isn’t the only one benefiting from the DEX game. Other blockchains like Polkadot and Solana have already created their own decentralized exchange ecosystems for their respective platforms and are interoperable at the same time. Although most interoperability protocols already have bridges into the Ethereum network, improved cross-chain support could be just what DEXs need to dominate the space.

Decentralized exchanges, however, have their pitfalls. For one thing, they do not protect against money laundering or implement robust KYC procedures. This could be a significant hurdle for regulators, especially if DEXs become the primary portal for trading cryptocurrencies. “DEX will be a huge headache for regulators,” Tao said, adding:

“Right now regulators are facing a gigantic technological challenge and the only way they can be part of this innovation is to improve legacy systems to catch up.”

There is evidence that criminals are using decentralized exchanges to conduct their business activities. Last September, $ 281 million worth of cryptocurrencies were stolen from the KuCoin exchange, and the perpetrators reportedly used the Uniswap decentralized exchange to trade stolen tokens for ETH, according to blockchain analytics firm Elliptic.

That being said, decentralized exchanges are little more than protocols that allow distributed nodes to communicate with one another. While they can be used for both good and evil, there is very little that the protocol itself can do to stop malicious activity. This is akin to the way the internet is still used for crime, and while security systems have improved so that the most heinous crimes can still be tracked, the internet itself cannot stop people from abusing it.

Related: BlockFi Facing Regulatory Heat, A Sign Of Possible Regulations For Crypto Lending?

Without centralized servers, it is virtually impossible to close down decentralized exchanges, making it unclear how governments could force them to comply. One solution involves a central gatekeeper to identify users on the log, but this is likely just a temporary solution that will soon be replaced by decentralized alternatives.

As digital assets continue to enter the mainstream, the infrastructure borrowed from the centralized financial administration has come under immense scrutiny in recent months, leaving both retail and institutional investors unsure of how to proceed.

The current DeFi and DEX ecosystems are still in their infancy, and the industry will only be able to build the financial infrastructure of the future through trial and error. As access to trading platforms and other financial services improves by eliminating factors of trust and lowering costs, digital assets could soon be adopted by the public.