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Are Loopring, DyDx, and DeFi Layer-2 Exchanges Clipping CEXes?
It is July 2018, and Vitalik Buterin thinks centralized exchanges “can go burn in hell as much as possible.”
Even then, those were strong words. The co-founder was nuanced in the same interview, acknowledging why it is harder for users to exist in purely decentralized or centralized systems.
Each system provided advantages, and they are mostly symbiotic, ensuring that the end-user easily transits in and out of the developing and nascent cryptocurrency sphere.
A look back, and DeFi is the name, and Layer-2 is proving to be yet another challenge for the gate-keepers of centralized exchanges.
For all we know, and cycling back to Buterin, new users would find it strenuous to plug themselves into the world of crypto without exchanging fiat for crypto. Centralized fiat-to-crypto ramps serve the critical role of onboarding users to the exciting world of crypto either for investment, experimentation, or HODLing.
Accordingly, while they may seem evil and unnecessary for hardliners and Ethereum maximalists, crypto wouldn’t be as round as it is without their liquidity and user onboarding.
However, while they play a critical role, their purpose is threatened by the growth of DeFi and the improvement in Ethereum throughput facilitated by the increasing adoption of Layer-2.
In an ideal situation, centralized exchanges would onboard, allowing users to acquire ETH, USDT, BTC, or any choice digital asset. After this, their role ceases. Once the coin is transferred to a non-custodial wallet like MetaMask, a user is free to do whatever they wish in the expansive and interconnected DeFi—across different chains in some cases. They only cycle back later to cash out or even use a peer-to-peer exchange instead of a centralized exchange.
This utility is why DeFi remains a threat, growing and sucking out liquidity from what would otherwise be lining up pockets of Brian Armstrong, Changpeng Zhao, and many more. The growth of DeFi, specifically in 2020, saw more analysts calling for the quick end of CEX, only forgetting their critical initial role of adding more fire to the DeFi fuel by bringing more users on board.
But even amid the rapid expansion, Ethereum—the home of DeFi—faces scaling challenges. The inability of Ethereum to process not more than 15 TPS proved limiting, causing congestion, which in turn saw fees rise to unmanageable levels. Despite the irresistible features of DeFi, for example, swapping, users couldn’t find the need to exchange a token for another while paying a fortune as network fees.
However, this seems to be coming to an end and being managed by the adoption of Layer-2s. Thing is, Layer-2 solutions are not perfect, but this is what we have now, and it is working. Re-routing transactions from the base layer to an off-chain “container” to ease the main layer is relieving. Fees remain higher, and the impact of Layer-2 hasn’t been felt as expected, but this is a good problem for Ethereum. Demand is high, and ETH holders are bullish because of this.
The widespread use of DeFi and integration of main players like Uniswap and SushiSwap present a bigger threat to centralized exchange than ever before. Interestingly, this was predicted by Vitalik in 2018. During the same interview wishing demise for centralized exchanges, he talked about the efficiency of using off-chain/sidechains to scale the base layer. Then he said these solutions can be as “efficient as centralized servers,” meaning user experience would be enhanced due to lower on-chain fees and faster settlement.
This is what the Ethereum community members find themselves with via DyDx, Loopring, Arbitrum, and more. These layer-2 solutions and exchanges promise to scale the base layer, and trading fees are negligible through their channels. Settlement is faster like it is transacting in centralized exchanges, yet the security is based on the main layer, with all operations done in a non-custodial wallet.
And the demand—the migration—is there for everyone to see. From July, there has been a 10X jump in Layer-2 TVL to $3.2 billion, with the majority held in Arbitrum. What’s even more intriguing and signaling interest is the narrowing of the Polygon—Layer-2 gap. While Polygon has a TVL of around $4.14 billion—in operation for longer, the surge in Layer-2 TVL makes for a pulsating competition in the days ahead. Then again, only launched recently, DyDx—a Layer-2 exchange-- now manages over $410 million complementing efforts on Loopring and DeversiFi.
Are CEXes beginning to “burn”?