FreightWaves attended Distributed 2018: Unlocking the Global Power of Decentralized Business, the leading enterprise blockchain conference, last week in San Francisco. Arthur Hayes, the charismatic cofounder and CEO of BitMEX, opened Friday’s agenda with a provocative keynote attacking the core premises of decentralized exchanges. BitMEX is the world’s largest and most liquid cryptocurrency exchange. BitMEX is also centralized, meaning that the trading platform and funds deposited are controlled by a corporation; recently, some decentralized exchanges have emerged, controlled by no one in particular, and Hayes questioned whether the problems they purport to solve are issues that crypto traders actually care about.
First, a bit of background on Arthur Hayes: he graduated from the Wharton School of Business at the University of Pennsylvania with a BA in Economics in 2008, then moved to Hong Kong to trade equities and derivatives for Deutsche Bank and Citigroup for five years. Hayes is an experienced futures, forwards, and swaps trader, which makes his comments on the ‘first principles’ of trading applicable to many kinds of financial instruments (for example, freight futures).
“What are the problems that decentralized exchanges purport to solve, and are these problems things that the market actually cares about?” Hayes began. Hayes went through what he called “the trader’s hierarchy of needs”: first is liquidity, then leverage, then ease of use, then security.
Regarding the first and most important need, liquidity, Hayes recalled the early days of his exchange and an early bear run, when the price of bitcoin dropped from about $600 to about $300. “The number one concern was liquidity,” said Hayes. “[Traders asked] how can I get in and out of a position and how much does it cost, and how many people are playing in the sandbox where I am? The number thing people complained about our platform was ‘where is the liquidity?’”
Then Hayes discussed how new exchanges trying to compete with incumbents are already at a disadvantage when it comes to liquidity. “If you look at the top 10 [crypto] exchanges, most of them have been around for three to four years,” said Hayes. “Even now, it’s difficult for a new exchange to become successful because of liquidity—if you want to trade, and other exchanges already exist, you don’t think of the #20-1,000 exchanges that claim to have better technology or claim to be more secure; [you think] ‘this exchange moves $1B a day, this one moves $1k a day, where am I gonna go trade?’ The number one concern of traders is liquidity—if you don’t have it you’re already at a massive disadvantage.”
“The next thing that a trader cares about is leverage,” Hayes noted. “The most successful exchanges are ones that offer people leverage—whether it’s margin trading or in a derivatives market (futures contracts where we set the initial margin and the maintenance margin). All of the exchanges in the top five have some kind of margin or leverage trading. If you don’t have the two Ls, liquidity and leverage, there’s practically no chance you’ll be successful.” Hayes went on to briefly discuss ease of use, including user interface and user experience, pointing out that the easier it is to acquire volume and trade, the more liquid the exchange will be.
Security was really the last thing that traders cared about—no one is going to deposit money into an exchange with very low trading volumes and liquidity even if it supposedly offers superior technology and security. Because security is the last of the trader’s hierarchy of needs, Hayes suggested, traders only have the luxury of caring about security after their liquidity, leverage, and ease of use needs have already been met.
Then Hayes turned his attention to emergent decentralized exchanges, called ‘DEXs’ for short. One of the most popular DEXs is IDEX, but there are several, and there’s even a protocol—essentially a primary layer blockchain akin to bitcoin or Ethereum—called 0x designed specifically for decentralized exchanges.
“The DEX value proposition,” Hayes said, “is, 1. clients maintain custody of their own funds at all times; 2. all trades happen on a public blockchain and are 100% transparent; and 3. the exchange is decentralized, so in theory it cannot be shut down.” Hayes questioned whether people actually want the responsibility to maintain the integrity of their own wallets and perform due diligence on wallet software, but said that DEXs offer it anyway. Then he said that “some people are uncomfortable with the idea that a centralized exchange maintains control over the record of all the trades, but this has pros and cons… all the public blockchains at the moment are extremely slow compared to a centralized exchange.”
“Do traders want slow but transparent trading or fast and centralized trading? They don’t care about the back end as long as their trades get matched, and they own the asset they want to own,” claimed Hayes. Hayes also attacked the notion that decentralized exchanges could not be shut down because they have no one ‘in control’ of the protocol, pointing out that even completely decentralized projects have teams of developers and public faces. “If I’m a regulator and I see there’s people representing themselves on the internet as developers of a particular protocol and people trust them, and that there are these three dudes or gals that I can harass on Twitter or Slack to do something, who are the regulators gonna f—k? These guys—the notion that a decentralized exchange can do whatever they like and escape the wrath of regulators is totally naive,” Hayes alleged.
Finally, Hayes disputed the idea that crypto traders are motivated by some kind of crypto-anarchist philosophy and would pursue decentralization for the sake of decentralization. “Most traders don’t give a flying f—-k about the underlying asset they’re trading,” Hayes said as his audience laughed. “Why do people actually want to trade crypto? Volatility—unlike most assets, crypto moves aggressively. Access—holding and trading isn’t only for the wealthy or institutional investors. 24/7 trading—the markets never sleep and you can trade whenever and wherever you like.”
Hayes concluded his keynote by saying that at the moment, decentralized exchanges are a novelty and won’t be important for at least five to ten years because in the short and medium term, the problems that DEXs try to solve aren’t problems that traders actually care about.
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