Centralized Exchange Scrutiny Will Spur Research of Decentralized Exchanges

The push following the FTX exchange’s collapse to regulate centralized crypto exchanges will likely be a net positive for those looking to expand their understanding of crypto. I don’t say that as someone who advocates for or against regulation, but as someone who expects crypto participants to adapt as the environment shifts.

I recognize the importance of regulation, but am sometimes skeptical of the motivations behind it. I also live on Earth, more specifically New Jersey. So I walk around with the underlying assumption that regulation, like bad traffic, is largely unavoidable.

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All three things involve centralized exchanges (CEX). That root word “central” sure looks like a regulatory bullseye now.

When I was early in my crypto journey, centralized exchanges served as a welcome on-ramp where I could set up an account, link to a bank account (letting me easily bring fiat money into the digital asset realm) and then press a button and see that I’d just purchased bitcoin (BTC). I also provided loads of personal information during the Know-Your-Customer (KYC) process.

For purists, this all runs completely counter to the crypto ideal of decentralized, trustless, peer-to-peer transactions. I actually think the existence of centralized exchanges is a positive. For many investors it represents a comfortable way to gain access to this space, via an accountable entity. I expect them to stay.

But I also expect that the recent crackdown – and, in all candor, I think some of the increased scrutiny has been earned following the bankruptcy of FTX – will accelerate the learning curve for those willing to dive into decentralized exchanges (DEX), which operate very differently from anything you see in traditional finance (TradFi).

As an investor, my interest would not just be in the exchanges themselves, but also the tokens associated with them and their economics. For market-centric people from the TradFi world – as I am – that requires a certain level of commitment to learning the technical differences behind many of these protocols.

Certain fundamental attributes are certainly worth paying attention to. For starters, with DEXs you will largely be dealing with code as opposed to humans. Math as opposed to management. Unlike crypto CEXes, DEXes do not really resemble the New York Stock Exchange or Nasdaq.

Decisions that management teams make within CEXs are instead handled at DEXs through a vote among token holders. Governance is enforced in a trustless and decentralized manner.

For point of reference, the largest DEX by market capitalization is Uniswap. The $5 billion market cap of its UNI token pales in comparison to Binance’s BNB token ($48 billion). In a sense this illustrates the potential opportunity that exists within the DEX landscape.

The distribution of capital from DEXs also presents some interesting opportunities. Akin to stock buybacks in the traditional world, DEXs will often distribute value back to token holders via a token burn, or a token buy back and burn. In short, the objective is to reduce the supply of the asset, which (when supply and demand dynamics hold true to form) lend to increased values for the asset.

In fairness, this is done by both centralized and decentralized exchanges. The distinction with DEXs, however, is that while a CEX has to consider the interest of both individual shareholders and token holders, no such conflict exists within DEXs.

There is no company president or management team to consider. Only the token holders themselves, who can often vote for or against the payment mechanism. The decision is up to the network itself.

DEX tokens often provide incentives to holders on the basis of yield generation, reduced trading fees and governance. As the demand for usage of the network increases, the value of the asset is likely to as well, without the overhang of malfeasance, and the extreme target of regulators (at least for now).

All told, increased scrutiny of centralized exchanges will likely lead to increased knowledge and adoption of decentralized ones. In many ways, this aligns closer with the original Bitcoin white paper, which in large measure kicked everything off.

From CoinDesk’s Nick Baker, here’s some recent news worth reading:

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