Decentralized exchanges (DEXes) are all the rage in the present decentralized finance (DeFi) industry. These exchange markets do not rely upon a third-party service provider to hold customer funds, a major advantage over traditional exchange structures. Instead, in DEXes, funds are traded in a direct peer-to-peer (P2P) manner via automation without any form of central authority. DEXes thus have the advantage of being trustless, meaning that users do not need to trust the exchange or a third party to hold their funds, as users retain custody of their own funds until the trade occurs. DEXes are also highly private, as users do not need to disclose their personal details to trade (unless a bank is involved). Another benefit of decentralized exchanges is that they do not have any server downtime and are protected from hacking, thanks to the distribution of hosting throughout a variety of nodes. Despite these common benefits, the presently available DEXes are quite varied. It is often cumbersome for users to choose the DEX that optimally suits their needs. In this article, we will explore the most popular and promising DEXes, and compare the benefits and pitfalls of each. Category 1: Not Quite Decentralized Exchanges Many of the earlier attempts at DEXes were not truly decentralized, and either used a centralized server or trusted third party for order relay and matching. These included IDEX, DDEX, 0x relayers, Airswap, Oasis DEX, and others. Although EtherDelta and Paradigm markets were more decentralized, they have several major security flaws and programmatic weaknesses which hamper growth and long-term viability. While these initial attempts at DEXes left something to be desired, they pioneered the way for more truly decentralized exchanges to enter the space. Category 2: The Liquidity Pool DEXes Uniswap, SushiSwap, and Mooniswap are some of the biggest DEXes, fighting with one another for market dominance over the last few months. Uniswap has a total of $2.70 billion of value locked into the protocol as of October 18, 2020. This number also makes Uniswap the top decentralized application (DApp) available in the world, holding an impressive 24.15% of the total market share. While these three protocols have been vying for supremacy, at the end of the day, Uniswap, SushiSwap, and Mooniswap are incredibly similar. They all stem from very similar codebases and operate in highly similar manners. While occasionally one of these protocols will introduce a new component that swings users to its platform (like SushiSwap’s issuance of a governance token which catapulted it to brief market dominance), the others tend to be quick to follow (like Uniswap’s subsequent issuance of a governance token which brought it back to the number one spot). The overall premise is also the same: automated market making (AMM) via liquidity pools. These liquidity pools are alternatives to orderbooks for representing liquidity on these platforms. In finance, orderbooks are used to derive asset prices or match buyers to sellers. To date, orderbooks have been largely avoided by DeFi products as the ETH network has proven too slow and too costly to support them, necessitating intermediary infrastructures. However, the downfall of automated market makers (AMMs) like those involved in Uniswap, SushiSwap, and Mooniswap, are multifold: Liquidity cannot be provided unilaterally; liquidity must be provided for both sides of an exchange. Prices cannot be set, only the current market price is an option which can lead to slippage. The volume of an asset cannot be chosen without the need to put in an even higher volume backing it. Instances of front-running with bots often taking advantage of orders and buying them up quickly for a profit. Category 3: The Orderbook Underdogs A few projects have appeared on the scene which reject the idea that orderbooks cannot be decentralized. The two primary players in this decentralized orderbook space are Serum and . These protocols have developed order relays with on-chain settlements. Nodes of the and Injective chains host a decentralized, censorship-resistant orderbook storing and relaying orders for spot and derivatives trades. Injective Protocol Serum This new orderbook methodology invalidates the misconception that orderbooks cannot occur efficiently or effectively on the blockchain. This is quite the programmatic achievement, as orderbooks are some of the most computationally intensive tools on the blockchain. Serum and Injective use these orderbooks to drive pricing and order matching. These orderbooks are faster and cheaper compared to AMM strategies, in addition to avoiding the previously listed limitations of AMMs. The biggest difference between Serum and Injective is their fee structure. While both charge transaction fees, only Injective charges fees that compensate those doing the order relays (i.e. relayers), rewarding them for driving liquidity into the protocol. While Serum and Injective are both highly efficient and entirely decentralized, Injective offers the best user incentives in the long-run. In addition, Injective operates on a layer-2 structure building on Cosmos SDK, making the network devoid of gas fees and offering higher speeds in general than their competitors. Key Takeaways: There are quite a few DEXes, making it difficult to discern which protocol is the best. While Uniswap has the highest value locked in so far, this protocol is remarkably similar to SushiSwap, Mooniswap, and others that rely upon automated market makers and liquidity pools to determine prices and match orders. This model is quite restrictive, as well as being more expensive and slower. A couple of innovative protocols have found a way to subvert these issues, crafting orderbooks that are able to operate along the blockchain in an entirely decentralized manner while enabling cross-chain trading. While both Serum and Injective have achieved this programmatic feat with superior user experience, Injective supersedes competitors by offering better rewards, no gas fees, higher speeds, and better referral on-chain referral incentives structure for its users. Overall, just because a protocol is popular does not mean it is the best available, and users would benefit from evaluating the pros and cons of each DEX when seeking to exchange their digital assets.
