DEXs rake in the retail volume while institutions stay on the sidelines

If you were paying attention to the crypto market in 2018, you will recall that it was bursting with anticipation for what was supposed to be inevitably coming next: institutional adoption.

Suffice it to say, things have not turned out as anticipated.

In 2018, a number of players gate-crashed the institutional market hoping to get in on the action early. Venture capitalists poured cash into firms like ErisX and Bakkt, which were jockeying to be first in line to capitalize on an institutional derivatives market. Elsewhere, crypto-native exchanges like Coinbase worked on products that were supposed to lure Wall Street asset managers and traders to crypto.

Meanwhile, so-called decentralized exchange protocols — many of which were sitting on fat treasuries from the ICO boom — languished. Between the lack of liquidity and clunky user experience, few traders were drawn to the Ethereum-based trading protocols.

Oh, how the tables have turned.

Now, DeFi mania is in full-swing, echoing the heady days of 2017 — and the action on decentralized exchanges is beginning to outstrip some of the players in the centralized exchange world. And in many respects, institutional exchanges and offerings have failed to deliver on the hype of 2018.

Coinbase, for example, shut down its Chicago outpost, which was developing a low latency matching engine built for high-speed institutional traders. Seed CX, a hemp exchange-turned-institutional crypto exchange, shut its matching engine down earlier this year to pivot to settlement. At Virtu-backed ErisX, volumes in its ether and bitcoin contracts stood at zero thought the entirety of this week, suggesting perhaps that it is not even open for business.

There have been some exceptions, of course. UK-based LMAX Digital witnessed impressive growth in 2019, although that has stabilized in 2020. On the futures side, CME Group has built an sizable market in bitcoin futures.

Still, DEXs are now finally enjoying their time in the sun. In fact, Uniswap, the darling of DeFi, is currently doing more volume than LMAX Digital and Coinbase Pro, each of which bill themselves as professional trading venues.

Source: The Block Research

It’s not just volumes that reflect the ballooning interest in DeFi. This dynamic has been reflected in the talent firms in the market are on the hunt for.

"I will say 'DeFi' hiring, or just general hiring around decentralization focused projects has grown rapidly in the past 6 months," noted Rob Paone, founder of Proof of Talent. "A year ago, it was basically dead. A year ago, it was nearly all centralized companies."

DEXs are still clunky and few are clocking in volumes comparable to Uniswap. But all the recent action in the DeFi market gets at the heart of what was supposed to make crypto unique in the first place: accessibility.

While institutional asset-management firms have been slow to move into the crypto market, individual retail traders appear to be flocking into DeFi just like they have flocked into the equities market. Stuck at home with little to do, wanna-be traders are glued to their screens looking to punt any asset — traditional or not — from which they can squeeze a return.

Source: Morgan Stanley 

Crypto stands out in this context because of its relatively low barrier of entry. Unlike centralized venues, there is "zero friction on Uniswap from an 'onboarding' perspective," noted one exchange executive. "Also none of that pesky regulatory stuff to deal with."

Besides that, the incentives to trade on many of these platforms are worth the risk and clunkiness in a way that wasn't necessarily the case in 2018. Traders can flip coins for eye-popping returns or liquidity mine to scrape huge yields.

As for institutional exchange ventures, their failure to launch is rooted in different dynamics. It’s always been a difficult task to nudge firms to such a small market, known for exchange hacks and grifters. And even when they are interested in dipping into crypto, institutional exchanges are struggling to lure them to their venues due to lack of liquidity.

"It's hard to outcompete crypto exchanges without getting critical mass of liquidity or a reason for institutions to believe that you will," one market specialist said.