Why DEX is not (yet) favoured by traditional finance

"Today, it is not possible to directly exchange a Total share for an EDF share. Decentralised exchanges could solve this problem," explains Guillaume Burtschell, associate director of Finegan Advisory, whose past experience includes Société Générale and Binance France.

The best-known DEX (Decentralised Exchange) is of course Uniswap, founded in 2018, which offers a kind of automated settlement on the blockchain, a process that is normally carried out by a company within a traditional exchange such as Nasdaq. In the case of Uniswap, it is smart contracts that carry out this operation.

This feature offers many promises, including the reduction of intermediaries and therefore fees, as well as the possibility of trading 24/7 via systems that are more open than in traditional finance.

"But for the time being, traditional players are rather cautious about using this type of tool, which they are still unfamiliar with", Sergej Kunz, co-founder of 1inch, one of the largest DEX aggregators in the sector, tells The Big Whale.

This cautiousness is illustrated in particular by the fact that "the share of on-chain trading currently represents only 5% to 10% of total exchanges in the crypto sector. And in this price range, the majority of trades involve arbitrage operations," notes Cyrille Pastour, co-founder of Swaap Labs, the company behind the Swaap Finance protocol, a market maker operating in decentralised finance (DeFi).

There are several reasons for this reluctance:

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‍👉 Lack of identification of counterparties

"Most DeFi products, including DEX, do not comply with traditional finance standards. There is no KYC (Know Your Customer), which makes it difficult to identify potential counterparties with which financial institutions might interact," notes Sergej Kunz.

When a user goes to place an order to carry out a transaction, a multitude of protocols can be called upon (DEX, DEX aggregators, etc.) depending on the complexity of the request.

"Between liquidity providers, any market makers involved in the transaction or even infrastructures such as bridges, the number of players approached can quickly climb," explains Cyrille Pastour.

"Financial institutions need to know the identity of all the players with whom they are likely to interact," details Guillaume Burtschell. "Over and above regulatory issues, knowing the entire value chain is essential in order to have visibility over price formation", he points out.

👉 Lack of control over price formation

As Cyrille Pastour points out, while centralised exchange platforms such as Coinbase are better able to offer simple-to-measure fee structures, "these guarantees are much lower on blockchain where many technical factors come into play".

In addition, some blockchains sometimes stop working for several hours, such as Solana (but not Ethereum, on which most large DeFi applications are built), which is also likely to cool traditional players. "Something unthinkable in traditional finance", points out Guillaume Burtschell. It is also not uncommon for networks to be congested, with an impact on transaction fees.

Less well known, players specialising in block arbitrage on Ethereum can also have a significant impact on price formation based on Maximal Extractable Value (MEV).

"This type of player will take advantage of the time lag (slippage) specified by a user ordering a transaction. Depending on how long it takes to validate a block, a transaction can sometimes take up to a minute on Ethereum. Some players have developed robots with the ability to order blocks and therefore mechanically influence the price of a transaction", explains Cyrille Pastour.

But in an attempt to offer more reliable solutions to institutions, some players are getting organised, surfing in particular on the wave of "intents", a trend that has been rising steadily for several months. This is based on pre-established price conditions that are triggered only when they are met, leaving the minimum to market conditions (read our analysis of Across Protocol, a new-generation bridge that uses intents).

👉 Intents to the rescue?

CowSwap, which handled $3.4 billion in trading volume in March, has distinguished itself in particular by basing its exchange solution on this principle. More recently, Uniswap has also launched UniswapX, whose model is also based on intents.

If these solutions have emerged, it is mainly thanks to the proliferation of market making solutions that allow a multitude of players to compete to offer the best price. "This competition leads to better prices, but above all to price stability, an essential parameter for attracting institutional investors to DeFi", the CowSwap team explains to The Big Whale.

"In the case of intents, the user submitting a transaction will be able to tell a protocol the price target he wants to achieve. Thanks to this technical solution, it is sometimes possible, in certain cases, not to pay any transaction fees", explains Cyrille Pastour.

"Intents allow users to carry out a transaction by asking them what they want to do, rather than how to do it. They provide greater simplicity and, above all, reliability in price formation", boasts 1inch co-founder Sergej Kunz, who recently integrated this solution into his aggregator and who is working closely with several leading financial institutions on the subject (notably MasterCard).

"Several players have formed partnerships and are beginning to have an interesting network effect, enabling them, in some cases, to control almost the entire value chain of a transaction. Mechanically, this opens the door to better identification of counterparties. From a regulatory point of view, it's a huge step forward," says a DeFi market maker well known to the sector.

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