In 2020, at the height of the so-called DeFi Summer, decentralized cryptocurrency exchanges (DEXs) bloodied the nose of their centralized counterparts as traders flocked en masse to protocols like Uniswap, Kyber and PancakeSwap. Inevitably, this frenzied trading activity led to breathless op-eds announcing that trustless trading was the future — DeFi wasn't just a novel way of financializing the crypto industry, its proponents argued; it was a new paradigm for trading full stop.

Alas, that vision hasn't come to pass. Yet the dream hasn't died. While it's fair to say that permissionless trading apps — the sort that eliminates intermediaries and flies under the DeFi umbrella — have experienced ups and downs in recent years, particularly as the crypto market has turned choppy, their ideological appeal hasn't waned, which suggests their proponents are on to something.

CEX vs. DEX: The Key Battleground

In traditional finance (TradFi), centralization is king. Centralized systems see trading controlled by one entity following a central limit order book (CLOB) design, with parties recording their willingness to buy (bids) and sell (offers) an asset. With these intentions thus known, the central authority facilitates trades when one offsets the other.

Decentralized trading protocols, on the other hand, rely on smart contracts to automate trades once certain conditions are met. In doing so, they eliminate the need for a central authority and allow for more transparency, since all parties have access to the same real-time, blockchain-stored data. What's more, traders retain control of their own funds.

It is interesting to note that the biggest sources of financial contagion in the cryptocurrency industry last year were well-established centralized firms, namely Celsius, FTX, Voyager Digital and Three Arrows Capital. Although a separate implosion at Terra Luna caused the DeFi space some reputational damage, it soon became clear the project was DeFi in name only. Genuine DeFi projects, including Aave, MakerDAO and Compound, were largely immunized from the fall-out.

With their slick UX and deep liquidity, centralized platforms have long been the preferred gateway to the world of crypto trading. However, the collapse of FTX, the high-profile exchange that misappropriated $8 billion of user funds, caused the scales to fall from many traders' eyes. All that glitters isn't gold, and despite its stellar reputation, FTX was exposed as a giant scam powered by little more than hubris. Following its crash, DEX tokens pumped by 24% while their CEX counterparts saw a 2% decline.

If the FTX imbroglio showed us anything, it's that electronic trading is ready to evolve from closed-loop black box systems to decentralized, transparent and trustless exchanges and not just crypto trading, either.

The arrival of third-generation blockchains — particularly Avalanche, Solana and application-specific blockchains that reduce fees and create a non-custodial relationship between exchanges and users — has changed the game. The belated arrival of central limit order books on the blockchain means TradFi trades can be brought onto a distributed ledger, with all the attendant benefits already enjoyed by DeFi users.

Why Decentralized Trading?

There are, to be sure, many advantages of decentralized electronic trading, from near-instant peer-to-peer settlement to cryptographic security and a lack of centralized bureaucracy. While TradFi as an industry may resist change, it should pursue whatever innovations benefit end users, particularly if those innovations enhance transactional security.

The intrinsic benefits of decentralized trading were emphasized by the aforementioned blow-ups, which saw centralized players conduct shady dealings without scrutiny, in many cases using customer funds to make risky market bets. Non-custodial relationships between customers and exchanges eliminate these conflicts, setting the scene for a truly trustless relationship that all asset classes need to evolve.

And there are other considerations, too. Closed-end centralized systems are incredibly expensive to build, with the existing model requiring a private company to build and manage hardware infrastructure that, in the case of a large bank, can easily run into tens of millions of dollars annually. By comparison, decentralized architecture shifts the cost to the validator network, with participants incentivized by the native gas asset of the network. The potential savings to be made from switching models are significant.

Moreover, CEX trading isn't fully optimal in terms of speed. This is particularly the case in FX markets, where the concept of "Last Look" means liquidity providers have the option to reject a trade even if they are showing the price to the taker for a certain duration of time (typically within 50 to 100 milliseconds). Additionally, while trades may execute in mere milliseconds, TradFi settlement still takes anywhere from one to three days. In the case of CEXs, it only occurs when the user withdraws, complicating matters further.

We have thankfully reached the point where decentralized executions can happen at similar times to CEXs, with instant-settlement and comparable UX. Decentralization gives more power to individuals and makes systems less open to attacks by malicious actors, fostering trust, financial freedom and choice. Ultimately, decentralizing electronic trading is a net good for humanity, paving the way to a more convenient, efficient and safe experience for all.

(Berk Ozdogan is the head of strategy at Dexalot, a trustless, non-custodial, decentralized central limit order book exchange deployed on an application-specific subnet on Avalanche. He is also one of the founders of FireStorm Capital, an investment fund focusing on managing digital asset exposure in a systematic and quantitative way for partners and outside investors.)

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