As DEXs struggle, new approaches kindle hope

In May 2022, at the tail of the crypto bull market, economist Eswar Prasad wrote an op-ed for the Financial Times arguing that DeFi’s promise as a means of democratizing finance was a long way from being realized. In his words, “For all its promise in democratizing finance and broadening financial access, the emerging reality suggests a concentration of economic power, while the risks fall largely on those investors least able to handle them.”

Prasad is right that early DeFi projects catered almost exclusively to crypto natives, often called “degens” in Twitter parlance. However, he didn’t acknowledge that this is in fact a common pattern for any nascent industry crossing the chasm from fringe to mainstream adoption. New, transformative technology frequently starts out looking like a toy. The internet went through this same phase, as did many of its formative companies, such as Facebook, whose target audience grew from college students to anyone in the world with an internet connection.

This article explores how one foundational building block of DeFi — the decentralized exchange — emerged and continues to evolve from being a toy to a serious product that rivals traditional centralized exchanges.

The heart of DeFi — The decentralized exchange

At the core of any financial system, DeFi included, is the ability to exchange assets. In order for DeFi to rise from nothing to hundreds of billions of dollars in value, it required an easy way to trade tokens. This gave rise to the decentralized exchange, or DEX. The best example is  Uniswap, which is by far the most popular and successful DEX in DeFi.

The idea behind the exchange adheres to the tenets of DeFi: It serves as a transaction hub where users can exchange a variety of different currencies without the necessity of an intermediary. However, Uniswap acts as an automated market maker (or AMM), where users can trade against a smart contract acting as a counterparty.

While fulfilling those functions was enough for the platform to break out onto the world stage and carve out the biggest slice of the emerging market share — one that the exchange maintains today — Uniswap is not a perfect solution and the AMM model has several flaws.

The trade-off with AMMs

AMM exchanges pool the liquidity they get from liquidity providers, and employ algorithms to price their supported assets within that pool. This model proved hugely successful for Uniswap in its early days, as it allowed easy sourcing and…