Onchain trading has come a long way in the last five years. From the creation of the first AMM in Uniswap, which was streets ahead of early forerunners such as EtherDelta, to cross-chain aggregators, decentralized limit orders, perps, and prediction markets, trading onchain today is light years ahead of how it was in the original DeFi summer of 2020.
But for all the improvements that have been made to the DeFi trading experience, and the new features added, onchain volumes remain a fraction those of centralized exchanges, with the former capturing around 20% on a good day and closer to 12% at other times.
If more users are to participate in onchain trading and the benefits it brings, particularly in terms of being able to retain control of their assets at all times, there are three key barriers that must be addressed. While the technology exists to improve all of these problem areas, until it’s widely adopted, onchain trading will remain a subset of total crypto market volume. Let’s take a look at each issue in turn and examine the strides being made in improving it.
The Case for Onchain Trading
The permissionless design of decentralized exchanges makes them globally accessible to virtually anyone. Compared to CEXs, DEXs are more inclusive and also more private since in most cases user verification is generally not required – though that privacy is all relative, as we’ll discuss later. The fact that assets don’t need to be custodied when trading onchain is also a major bonus since it eliminates the risk of exit scams and asset seizure.
These are the most obvious benefits to DEX trading. But they’re by no means the only ones. One of the primary reasons why DEXs pull in billions of dollars in volume every day isn’t because traders don’t trust CEXs: it’s because onchain is where the best opportunities lie. Anyone can launch any asset using a liquidity pool, resulting in a virtually unlimited number of tokens to trade. If you want to catch the upside to the best emerging memecoins, DeFi assets, and AI tokens, you don’t wait for Binance to list them – you go straight to the source.
That’s the bull case for onchain trading. But if it was that rosy, everyone would be performing their crypto swaps onchain and CEXs would be dying a death. The reality is that for all the benefits they bestow, web3 can be an unforgiving environment. From scam tokens to phishing attempts and from high slippage to scammy projects, there are hazards galore. Different risks to those faced when trading on centralized venues, but hazards nonetheless.
While some of these issues can be swerved through commonsense, such as avoiding new tokens and trading on established DEXS, other issues are harder to skirt – with the following three proving particularly pernicious.
Three Onchain Issues to Fix
The first key issue impeding onchain trading pertains to liquidity. In short, there are too many chains and not enough liquidity to go around. Every time a new Layer 2 or DEX launches, it siphons users and liquidity away from existing platforms. As a result, liquidity has become fragmented and slippage is endemic, causing users to lose money on each swap they make versus a comparable CEX trade. Low liquidity is a particular deterrent to traders trying to swap with size, rendering most blockchains off-limits to pro traders and institutions.
The second issue concerns the technical barrier associated with DEX trading. If you’ve spent years in the crypto trenches, chain-hopping and exotic asset swapping comes naturally. But for beginners, it’s a lot to take in. Gas tokens, seed phrases, network fees, connecting wallets, bridging funds, checking for slippage, approving tokens to name but a few are impediments to broader adoption. Throw in UI/UX that varies greatly in quality – but which is often suboptimal, and looks nothing like web2 interfaces – and the technical barrier is a high one to surmount.
The final issue is one we’ve briefly touched upon earlier: security and privacy concerns. On the one hand, DEX trading is pseudonymous, allowing individuals to keep their real-world identity private. But on the other hand, their every transaction is publicly broadcasted, making it a cinch for onchain observers to track their wallets, copy their trades, and even view their wallet balances. Throw in the persistent security concerns, ranging from smart contract exploits to front-end hijacking, and the onchain landscape can feel like a battlefield at times.
Three Practical Solutions
Some of the solutions to these challenges are obvious. Others are more ingenious and have taken time, trial and error to arrive at. But combined, the technology and means to mitigate all of these problems has already been developed even if it’s yet to be widely adopted.
The solution to the first issue – liquidity fragmentation – has been effectively solved. It entails utilizing liquidity layers that direct shared liquidity from multiple blockchains and DEXs to where it’s needed. As a result, a trader can set up a swap on Arbitrum, say, and it can be filled using assets that are pooled on Optimism or even a non-EVM such as Solana. Projects such as Orbs have been instrumental in driving this trend, with its L3 delivering onchain liquidity to DEXs across multiple blockchains.
Orbs can also procure liquidity from CEXs, allowing DEXs to provision it to their users without introducing custodial chokepoints. As a result, any DEX or emerging blockchain can tap into the liquidity it requires on demand – whatever the asset being swapped and now matter how large the order. The same L3 technology also improves transaction speeds and reduces costs. Dozens of DeFi protocols have already integrated liquidity layers such as Orbs; it’s now a case of waiting for the rest of the industry to catch up.
As for the technical barrier that bedevils DeFi, solving it is largely a case of better interface design and a focus on UI/UX which should be the first consideration of onchain protocols – not an afterthought. The best DeFi protocols are characterized by seamless user experience, slick onboarding, and extensive tutorials and customer support. The problem is that such platforms are the exception rather than the norm. For every Aave, there’s a dozen rough-and-ready DEXs that are suitable for seasoned degens only.
DeFi needs to enforce uniform standards across the board, or rather across the chains so that users can expect the same quality of UI/UX regardless of the network or platform they’re trading on. This calls for joined-up thinking – something web3 is notoriously bad at. Well-designed web3 solutions are already here: they’re just not evenly distributed.
Finally, the lack of onchain privacy is being addressed through the emergence of L2s such as COTI and Fhenix that offer private transactions, as well as networks harnessing ZK proofs to achieve the same outcome. Again, though, it will take time for these technologies to ossify and be widely adopted. As for the security concerns, while web3 will likely never be free of attack vectors, better defensive tooling, including AI-powered threat detection and analysis, is giving protocols and users alike better tools with which to safeguard their assets.
Onchain trading today is effortless if you’re a pro, relatively straightforward if you’re an intermediate user, and bewildering if you’re a total newb. Just as the internet once came with a learning curve, the same holds true of DeFi today. But it doesn’t have to be this way and it won’t be this way for long. While onchain volumes may never eclipse those of CEXs, there’s no reason why DEXs can’t grow market share if they can solve the biggest problems that are impeding growth.
