Can Decentralized Exchanges Compete With Coinbase?

Jun 4, 2021

Coinbase is the largest and most trusted cryptocurrency exchange in North America. Globally, it usually ranks behind Binance and Huobi (according to crypto exchange rankings).

Moreover, Coinbase recently debuted on Nasdaq with a $100+ billion valuation and topped TikTok for the #1 spot in the Apple App Store. During its S-1 filing ahead of the Nasdaq listing, Coinbase singled out decentralized finance, or DeFi, as the most significant threat to its success.

Can DeFi exchanges like Uniswap, Sushi, and PancakeSwap compete with Coinbase? Let's dive into the facts, figures, and possibilities surrounding how DeFi can overtake the darling of centralized crypto exchanges.

Top 5 CEX as of May 2021
Top 5 DEX as of May 2021

Coinbase is synonymous with crypto

To the untrained eye, Coinbase has the crypto exchange game wrapped up. After all, who can compete with an entity hiring Goldman Sachs execs as liaisons in Washington DC?

So far, Coinbase has trod the well-worn path of traditional centralized tech companies.

  1. Innovate
  2. Disrupt
  3. Become the new normal

Coinbase delivered a prolonged period of innovation, beginning with its Bitcoin exchange services in 2012. Over the next few years, the exchange received tens of millions of dollars in funding to bootstrap the disruptive phase of its operation. Coinbase turned buying crypto from a hackery experience into a simple one-click purchase similar to Amazon shopping during this time.

The simplicity of buying crypto using Coinbase led many in the United States to equate the exchange with crypto itself. Such is the new normal phase for Coinbase, a stage verified by the Nasdaq COIN listing.

Now, Coinbase is the incumbent, and all challengers seek to disrupt it and restart the cycle. Will the challenge come from within the centralized tech industry from, say, Robinhood?

According to Coinbase's internal documents, the company believes the nascent but highly disruptive DeFi industry will mount the most substantial challenge.

Why use DeFi exchanges over Coinbase?

Decentralized finance is quickly innovating open financial technology, enabling people to become their own banks.

Amongst the deluge of DeFi protocols available today are Uniswap, Sushi, and PancakeSwap — three decentralized exchanges leading the charge against Coinbase.

There are quite a few advantages decentralized exchanges hold over traditional exchanges — let's unpack them.

Trustless

When you trade on Coinbase, you do so using a verified account filled with your information. This means you're trusting Coinbase with your identity and are essentially allowing them to use your private data. For instance, Coinbase cooperates with the IRS and criminal authorities.

Decentralized exchanges don't require your data. Instead, you simply connect your cryptocurrency wallet and trade against an automated liquidity pool. Smart contracts execute everything, so you don't need to give your trust — the protocol simply runs.

Trade anything

Exchanges like PancakeSwap, Uniswap, and Sushi make it easy to add liquidity and trade any token. If you're a project founder, you can instantly enter the market using a token launchpad like Miso.

Since anyone can launch a token into the market by adding liquidity, you can trade these tokens well ahead of the curve. The seemingly endless array of token pairs available to you on decentralized exchanges makes Coinbase's list of traded assets appear limited.

It's important to note that decentralized exchanges generally use ETH as a base pair. In contrast, Coinbase uses USD as a base pair. If your trading stack is mostly crypto, decentralized exchanges are a native path to liquidity compared to Coinbase.

No regulation (yet)

Decentralized exchanges aren't regulated like Coinbase is. The disparity in regulatory rules is one of the reasons Coinbase cited DeFi as a threat to its business model in the first place.

Not having to jump through the usual hoops allows decentralized exchanges to quickly test, adapt, innovate, and ship new features. In this sense, trying to compete with a DEX is a bit like playing whack-a-mole.

For users, the Wild West nature of DeFi makes it the perfect playground for playing with cutting-edge financial products like liquidity pools, AMMs, lending protocols, and self-paying loans.

100% uptime

During the May 2021 cryptocurrency crash, centralized exchanges like Coinbase, Gemini, Kraken, and Binance all experienced downtime. Many traders were unable to withdraw tokens or buy the dip as the correction deepened.

Uniswap, Sushi, PancakeSwap, Bancor, Kyber Network, and Loopring remained online throughout it all. They had no trouble processing trades despite the increased volume. If the May 2021 crash was a stress test, decentralized exchanges passed with flying colors.

Advantages of using Coinbase vs. decentralized exchanges

In the previous section, we reviewed a few benefits decentralized exchanges hold over Coinbase. To summarize, the DEX experience is excellent for anyone primarily trading ETH and seeking deep liquidity across altcoin pairs.

Coinbase offers a very different tool for crypto traders and investors than DEXes do. It's not a highly customizable command center for buying tokens, earning interest, and actively borrowing/lending crypto. Instead, Coinbase is about spot trading and easy crypto investing with USD.

Extremely fast

Coinbase’s trading engine is fast and agile during times of regular trading volume. Decentralized exchanges are primarily built on Ethereum, so you need to pay a gas fee to execute a trade. Even at the fastest gas setting, transactions can take minutes or even hours to settle.

A trade using Coinbase or Coinbase Pro gets settled instantaneously. The transactions happen so quickly you might doubt whether they've been executed at all.

Incredible liquidity

Decentralized exchanges suffer from a problem known as slippage. In a nutshell, slippage is the increased price per unit paid the larger your order or the higher overall trading volume is. Some DEXes, like Curve, get around slippage by trading similar assets (stablecoins). However, Uniswap still hasn't figured out a work-around.

Coinbase is centralized and keeps the assets being traded on hand and organized by a central order book. Because there is no liquidity pool (as is the case when trading on a DEX), Coinbase offers deep enough liquidity to absorb even the most significant orders.

Insured wallets

One of the primary arguments for using a DEX vs. Coinbase is the former enables you to trade directly from your wallet. The problem with that is you must have strong security practices around your crypto wallet. Hardware wallets, two-factor authentication, and keeping multiples of seed phrases are all par for the course.

Even if you practice good opsec (operational security), if you lose your assets, no one can help you. In contrast, Coinbase wallets are FDIC insured against hacks, compromises, or losses that aren't user-error in origin.

No gas costs

Coinbase fees begin around $1.49 per trade and increase according to trade size. While Uniswap trading fees at 0.3% are lower than Coinbase, after you account for gas, Uniswap is usually pricier.

Decentralized exchanges are run on-chain. Until scaling solutions like Polygon or Optimism are more widely adopted, the fees paid to execute trades are likely to put off all but the staunchest DeFi supporters.

Optimism's latest status update revealed an estimated launch set for July

Which is better? Coinbase or decentralized exchanges?

Right now, Coinbase and decentralized exchanges appeal to different types of crypto traders and investors. Because of that, it's difficult to say one is better than the other — they're both perfect for different needs.

Here's an easy way to figure out which type of exchange is right for you.

Decentralized exchanges are better if you:

  • Are already familiar with crypto and own some (especially ETH)
  • Prefer to hold your crypto wallet private keys
  • Don't want to give your personal data to an exchange
  • Like trading small market cap altcoins and new projects
  • Want to migrate your gains to other DeFi protocols

Coinbase is better if you:

  • Don't mind submitting identification information
  • Prefer to let the exchange secure your crypto
  • Like an easy and fast way to buy crypto
  • Want to do your crypto investing on a mobile app

Will decentralized exchanges flip Coinbase or not?

The crypto exchange market isn’t a zero-sum game. In all likelihood, decentralized exchanges will peacefully coexist alongside Coinbase while each serves different needs.
However, an exciting development to watch out for is Coinbase’s possible integration of DeFi protocols into its platform. Coinbase Ventures is the exchange’s investment branch with a portfolio full of DeFi assets like Compound, Polygon, Reserve, Synthetix, and Celo. 

Are these investments a stepping stone for Coinbase to one day offer its users crypto loans via Compound? Conversely, perhaps DeFi apps will play nicely with Coinbase. Many already provide Coinbase Wallet compatibility.

The future of crypto exchanges isn’t black and white. Instead, you can expect a healthy mashup of financial products, services, and exchanges at your fingertips as the crypto development accelerates.

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