The Exchange Opportunity

Market Recap

Ethereum Breaks Out.


The Exchange Opportunity

This past week we witnessed history as Coinbase, a cryptoasset exchange, completed a direct listing on the Nasdaq. Coinbase has helped tens of millions of people buy bitcoin for the first time and has been an important bridge between the world of decentralisation and centralisation. Their listing to some has signaled crypto's mainstream moment.

Brian Armstrong conceived the idea of Coinbase in late 2010/ early 2011. After reading the bitcoin whitepaper, Brian understood the implications of an open monetary network and built a business based on this new fascinating asset. Today Coinbase processes over $4 billion in exchange volume daily and has a market capitalisation of around $75 billion.

Whilst the achievements and the story behind Coinbase remain genuinely inspiring, the business model employed is antiquated. Bitcoin and public blockchains are new communication networks for value. Most regulators, governments, businesses, and old school entrepreneurs look at cryptoassets and apply the only approach to finance they have ever known - centralise and control.

This approach is not the essence of decentralisation; it is a comprise. Coinbase is no different to the custodian exchanges of the traditional world. Over the long run, we personally favour investments into decentralised exchanges instead of into companies like Coinbase.

A decentralised exchange (DEX) is a non-custodial and permissionless exchange protocol governed by its users. When you use a DEX, you don't require permission to use it, you don't have to reveal your identity and most importantly, you remain in control of your funds.

This is not the same as Coinbase. When you deposit funds into Coinbase, you are no longer in control. Coinbase has built a walled garden honey pot of privately owned cryptoassets next to an open monetary network. In contrast, a DEX is an open protocol built on the open monetary network itself.

Coinbase uses old school approaches to provide access to something new. DEX's embrace the new and use blockchain technology to deliver their service. In the short run, Coinbase remains firmly ahead of most DEX's, but the future may very well tell a different story. If you, like us, believe the future is decentralised, then DEX's may present some excellent opportunities for you.  

There are obviously limitations to what DEX's can do today. The most significant challenge faced by decentralised exchanges is the trading experience itself. Many of you reading this are probably familiar with order book exchanges. These are order-driven trading systems where all trades are arranged directly from traders orders. In these trading systems, traders who issue limit orders help make markets and provide liquidity to other traders.

DEX's, especially those built on Ethereum, struggle to run order book based exchanges. This is due to the current lack of scalability of the Ethereum blockchain. Ethereum just isn't fast enough to process, execute and settle every order entered into an order book. Because of this, we have seen innovative ideas around different trading systems and auctions in general.

The most prominent execution system in DEX's today is the Automated Market Maker (AMM). AMM's create a liquidity pool of blockchain-based tokens, which are automatically traded by an algorithm rather than through an order book. This changes the trading relationship from order matching, to peer to contract. Not only can traders swap assets on these exchanges, but they can also put their idle assets to work in the liquidity pool and earn passive income from trading fees based on the percentage of the liquidity pool they provide.

There are paths forward that can leverage good old order matching exchange models though. A project called 0x is creating off-chain matching engines and routing orders between multiple exchanges. Projects such as Serum are utilising faster layer one networks like Solana to enable order matching on-chain. We should, over time, see different product-market fits occur. Order book exchanges have their benefits, but not all traders require the efficiencies they provide.

A review of the decentralised exchange landscape

Users

Whilst DeFi remains a small niche in financial services, the growth of users is truly jaw-dropping. These users come from all over the world and have different needs and reasons for using DeFi protocols. Since April 2019, DeFi users have grown by 9130%, and since April 2020, they have grown by 1092%. Are there any other centralised financial services growing at this rate?

Exchange Volumes

USD denominated DEX volumes are 65 times what they were this time last year and show no sign of slowing down.

Uniswap, a popular AMM, remains the industry leader accounting for 54% of total exchange volume.

The volume of DEX's over the last 12 months is $368 Billion, with a 30-day exchange volume of $58,7 Billion.

Market Performance

With remarkable growth comes excellent performance. Investing in DEX's has so far been incredibly rewarding.

The top performer YTD is ThorChain (967%). ThorChain is a cross-chain decentralised exchange that allows users to exchange assets between blockchains. Most blockchains are not interoperable with one another, so ThorChain has found a fit creating a bridge between the largest public blockchains. Uniswap has also put on show returning 671% YTD.

Not only is DeFi proliferating, but the industry also holds another considerable advantage over its centralised counterparts - DeFi protocols are governed by their users. Many, but not all, DeFi protocols have their own network token; this token allows holders to vote on upgrades to the very exchange they use. These tokens are distributed in various ways and can be used to incentivise users' attention on growing certain parts of the network.

For example, some exchanges perform liquidity mining where they issue their network token to users who provide capital to AMM liquidity pools. This creates more liquidity for users and enables the fair distribution of the underlying network token.

Not so long ago, Uniswap performed a retrospective airdrop of network tokens. This airdrop was awarded to any Ethereum address that had interacted with Uniswap before the 1st of September 2020. Users were able to claim 400 UNI tokens just for using Uniswap. Users become owners in DeFi. The airdrop of 400 UNI is now worth $14400 at $36 a coin.

This dynamic and inclusive governance mechanism is yet another reason why this space is almost unstoppable. Who better to guide the future trajectory of a service than the very people that use it? DeFi networks make constant improvement and innovation possible by directly allowing users' needs and wants to drive further development.

There's no denying that DeFi adoption is happening. We can see this from the increasing exchange volumes and active users to the total value locked in protocols. The growth of DeFi is staggering, and rightly so, these projects represent the first truly ground up re-architecture of our financial networks.

This is the internet of value. 


Notable Articles and News Stories This Week:

Berlin Hard Fork Is Now Live on Ethereum

This week the Berlin upgrade went live on Ethereum. The Berlin upgrade was the next step in the transition towards Ethereum 2.0 the Proof of Stake network. The Berlin upgrade’s most significant change was a reduction in high gas fees that have inhibited the platform to an extent. Developers and users alike were very excited as it was becoming prohibitively expensive to build on or interact with the network. We expect that this will encourage further development and encourage use going forward which is positive for Ethereum and everyone involved in the ecosystem.

Read more about the upgrade here

Rothschild Investment Buys $4.75M Initial Stake in Grayscale Ethereum Trust

The Chicago-based investment manager Rothschild Investment Corporation has recently made an investment into Ethereum through the Grayscale Ethereum Trust. This makes Rothschild among the first name-brand institutional asset managers to make an investment in the trust. In addition to this, they have also quadrupled their position in the Grayscale Bitcoin Trust over the first quarter of 2021.

Read more about the allocation here

BlackRock CEO Sings Bitcoin’s Praises as Future ‘Great Asset Class’

Larry Fink, CEO of BlackRock, the worlds largest asset manager with over $9 trillion in assets has stated he is “fascinated” by bitcoin and believes that it could become a “great asset class”. These comments come on the back of BlackRock starting to make allocations to the asset class. During a recent interview on CNBC, he stated, “I’m still fascinated about it [Bitcoin] and encouraged by how many people are focusing on it,” he said. “I’m encouraged about the narrative, it may become a great asset class and I do believe this could become a great asset class—cryptocurrency.”

Read more and watch the interview here


Whilst we all have the option to look, to seek to understand, it’s often easier not to. Bitcoin, Ethereum and distributed ledger technology are complex systems that require significant due diligence. At Etherbridge, we aim to lower the barriers to understanding this fast-growing digital economy.

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This is not financial advice. All opinions expressed here are our own. We encourage investors to do their own research before making any investments.