Centralized Crypto Exchanges Hope Regulation Will Blunt DeFi Threat

Crypto exchanges have been talking about the need for regulatory clarity for years, saying the uncertainty about basics like whether cryptocurrencies are or aren’t securities holds back the industry and puts them in danger of crossing lines they can’t see.

But there’s another reason centralized exchanges like Coinbase, FTX, Gemini, Kraken and others want the type of clear regulations that two U.S. senators proposed on Tuesday (June 7), and that various government agencies have been working on since President Joe Biden’s crypto executive order in March.

See also: Senate Crypto Bill Debuts, and Crypto Industry Gets Big Wins

They want protection from decentralized finance, also known as DeFi.

Read more: Biden’s Executive Order Set to Fast-Track Crypto Policy

If you go by the numbers, the decentralized exchanges (DEXs) at the heart of DeFi are proving far more popular than centralized ones (CEXs), according to a new report from blockchain data firm Chainalysis.

At present, DEXs have about 55% of the market as measured by trading volume, and CEX 45%; in other words, DEXs have been eating CEXs’ lunch.

Does that mean crypto is heading toward a decentralized future?

A New Crowd

Not necessarily.

If you dig in, centralized exchanges are becoming a bigger and bigger part of the crypto industry, despite the boom that made 2021 the year of DeFi.

A couple of factors are at work here; most notably, who’s using the exchanges.

The low fees and anonymity of DEXs — few, if any, collect personal data needed for anti-money laundering (AML) compliance — make them perfect for day traders, who execute hundreds or even thousands of trades daily, sometimes with the use of automated programs. The volatility of strong bull or bear markets gives these professional traders more opportunities.

However, if you look at the actual user growth in crypto, it favors CEXs: The number of new buyers — who are far more likely to buy and hold a few cryptocurrencies, giving them a lesser impact on trading volume — is growing rapidly.

According to PYMNTS’ new U.S. Crypto Consumer study, 23% of American consumers have bought or held crypto sometime in the past 12 months. That’s almost 60 million people, about 18 million more than a year ago.

Learn more: The Data Point: 23% of US Consumers Owned Cryptocurrency in 2021

And as DEXs aren’t easy to use, only those who get into serious, regular trading will switch. Some of the biggest advantages of centralized exchanges, besides their simple user interfaces, are their help desks and strong crypto custody capabilities in an industry plagued by stories of huge hacks that are overwhelmingly in DeFi projects.

Moreover, that trade volume ignores players like PayPal and Block, which are used primarily by first-time buyers.

Who Are You?

Second, there’s the growing global push to regulate all of crypto, including the decentralized parts.

While DeFi has a reputation as being deliberately difficult to regulate, the anonymity proponents tout so highly appears to be in jeopardy as regulations kick in across the globe and in the U.S.

A growing number of financial regulatory bodies like the Financial Action Task Force (FATF) and Bank for International Settlement (BIS) have said that DeFi projects in general aren’t as decentralized as they claim — from a regulatory perspective, there’s usually someone like developers or large token holders who can be called to account.

You may like: PYMNTS DeFi Series: What Is DeFi?

Centralized exchanges are already hobbled by regulators. Note the $100 million fine that BlockFi just paid to the Securities and Exchange Commission (SEC) and state regulators over its crypto lending program.

Those crypto lending programs are something CEX’s copied from DeFi, which the SEC only even hinted was under its purview when latecomer Coinbase was warned off last year.

That’s one reason CEXs are so eager to have strong regulations in place: They will provide a level playing field.

And DEXs can likely be regulated. As an industry segment, they actually fairly centralized. Just five — Uniswap, SushiSwap, Curve, dYdX, and 0x Protocol — account for 85% of the DEX trading volume at this point, Chainalysis said.

Compare that to the top five CEXs by on-chain transaction volume: Binance, OKex, Coinbase, Gemini and FTX accounted for about half of all on-chain CEX transaction volume.

Besides, on-chain is a key word there, Chainalysis said, noting that this only measures transactions sent to and from CEXs, which have large off-chain order books that cover large institutional clients like hedge funds.