Decentralized exchanges have surged in user activity over the past six months. At time of writing, major DEXs now transact in greater volume than the largest centralized exchanges, such as Coinbase. On the back of this rise in activity, Ethereum gas costs have ballooned as the majority of DEXs are built on the Ethereum blockchain. In this report, we diagram the heightened costs of using DEXs in today’s environment and the projected fees generated on the Ethereum platform.
Ethereum network set to generate $1.5 billion in yearly fees
One of the most popular market activities within DeFi is the concept of “yield farming.” Yield farming allows users to participate in the revenue earned by various DEXs and other transactional platforms. Users provide liquidity to DEXs, such as Uniswap, and in return receive reward tokens in the form of a yield on their staked capital. Reward tokens can then be sold in the market or used to stake across various other platforms or projects and receive additional rewards. The rewards are often paid out to stakers in the form of a platform or project’s native crypto currency.
In these decentralized ecosystems, interacting with smart contracts to stake and unstake assets and receive rewards are conducted over the Ethereum blockchain and as such require ETH for gas to interact with these smart contracts. Gas costs can vary depending on the complexity, and hence, number of processes undertaken in a certain smart contract(s). On some platforms, gas costs in order to yield farm can be as high as several thousand dollars. Nonetheless, the yield return that many of these platforms offer can still make the process highly profitable, resulting in a considerable demand for ether in order for users to yield farm.
Additionally, outside of yield farming, users have flocked to trading DeFi tokens as they have become the hottest new sector in the space. In order to place an order on these DEXs, ether is required for gas. While CEXs do not have gas costs associated with their trades, as they are conducted on a centralized platform that functions similarly to an in-house ledger, many CEXs are not fast enough to list the latest DeFi token. Because DEXs are decentralized, any user can upload a token, including the latest DeFi token. In times of heightened market euphoria, which we witnessed in the previous months before this week’s sharp crash, DEXs are often the first exchanges to list the latest DeFi project token.
Because of the increased demand for yield farming and DeFi token trading, the demand for ether has reached an all-time high. In the figure below we diagram daily ether gas used over time.
Figure 1: Ethereum daily gas used over time
On the back of this increased demand, gas costs have risen to a new all-time high. In the figure below, we diagram ether gas costs over time.
Figure 2: Ethereum gas costs over time
Gas fees generated through the Ethereum blockchain have reached a new high of ~$17 million per day. Looking at the previous seven day average shows lower fees yet still considerably higher than what they were in previous years. Over the past seven days, daily average fees are ~$5 million. If activity can remain at these levels, a simple projection would show yearly Ethereum fees generated at nearly $1.5 billion.
Background on Decentralized Exchanges
Currently, there exist several different variations of decentralized exchanges as the degree of platform decentralization lies along a continuum. In the simplest sense, a decentralized exchange is a platform that relies on a decentralized blockchain network, allowing users to trade assets peer-to-peer without relying on a centralized entity for liquidity or asset custody.
At the farthest end of the decentralization spectrum, a DEX would also allow users to execute trades without satisfying any regulatory intermediary steps (KYC, AML, etc) and list new tokens directly without needing third party regulatory or other approval. Centralized exchanges, on the other hand, control the custody of traders’ assets and must comply with local and national regulatory bodies which can impact customer services, asset trading, fees, and new token listings.
The perceived benefits of DEXs are quite clear. Nearly 6% of the total circulating supply of bitcoin have been attacked and stolen while custodied at centralized exchanges. Since 2011, more than $1.3 billion in digital currencies have been stolen from centralized exchange platforms. Additionally, the democratized listing process has allowed DEX users access to tokens that may not be available on any centralized exchanges. Further, because DEXs are decentralized, users may access the platform from any location, whereas centralized exchanges may prohibit access from certain countries, states, provinces, and regions.
Gas fees make DEXs costly trading venues for small size trades
In our in-depth DEX report in 2018, we diagrammed how DEXs were a lower fee alternative to CEXs. Even today, DEX fess themselves are still comparable or lower than CEXs. Uniswap fees are 30bps per trade, on par with fees at Coinbase and Kraken, among others. However, due to the incredibly high volume on these platforms as well as the rise in ‘DeFi yield farming’, the amount of daily gas used has hit an all-time high, which has pushed the costs for gas up to an all-time high.
With the rise in costs, each transaction on a DEX, which requires gas for transactions on the Ethereum blockchain, has become prohibitively expensive for low size trades. Gas fees represent those required to transact nearly instantaneously at levels at the time of writing. Note: as previously discussed, gas fees can change over time.
Figure 3: Total fee comparison small size trades
As shown, total DEX fees are prohibitively expensive for lower notional trades. On higher notional trades, however, the gas costs become more reasonable. In the figure below, we compare total fees for higher dollar cost trades.
Figure 4: Total fee comparison large size trades
DEXs for the first time are seeing real user demand and Ethereum is currently the leading base layer blockchain for these interactions–seeing a considerable increase in ether gas as a result. However, without additional scaling solutions, this increased demand is and will continue to hamstring activity as costs have been driven up considerably on these trading venues. As a result of the increase in costs, small size trades on DEXs are currently prohibitively expensive. However, our analysis shows that at larger size, these transactions are still on par with centralized exchanges, which indicates that DEXs are more suited for large scale traders. If successful scaling solutions are implemented in the future, DEXs can become leading exchanges for both smaller size as well as larger size traders.