There has been a lot of noise lately about the usage (or more specifically, the lack of usage) among decentralized exchanges (DEXs). Many have been built, but few users have come thus far. The reasons for low usage vary widely, depending on which side of the discussion you’re on, ranging from “it’s just too early to tell” to “bad user interface” to “a clear signal that crypto has no real use case.” Regardless, new DEXs seem to spring up every day, so let’s break down what’s driving the apparent paradox between rapid growth of exchanges and stagnant growth of exchange users.

First, some numbers:

According to inDEX, there are about 260 DEXs announced, in development, or operating. This includes both exchanges, protocols, and hybrids.

Of those, most DEXs are using their own project-specific protocols to facilitate trading and settlement, with 20% built on the 0x Protocol.

About a third of announced DEXs are released and operating, at least in alpha, while over half are still in development.

For the 34 DEXs listed in DappRadar, there were 4,135 users representing about 24,000 transactions worth over 12,300 ETH in the last 24 hours (as of Oct 17), with IDEX dominating the field and a long tail of DEXs with less than 5 daily users on average.

So, what’s driving the proliferation of DEX projects but anemic usage?

If You Fund It, They Will Build It

In the crypto space, project founders are particularly attuned to the types of projects that short-term and long-term investors fund. That’s true in any domain in which entrepreneurs are seeking capital, but the small number of investment theses in the crypto space has led to consolidation of investment (and thus projects) in a few areas. Throughout 2017 and 2018, exchanges have tended to be highly fundable, as “conventional” wisdom has been that crypto trading is one of the most, if not only, viable use cases at the decentralized application layer. As a result, project founders have flocked to where the investment capital is, proposing and building exchange protocols and dApps.

The Need Is Real, Even If the Usage Isn’t Obvious Yet

Setting aside the usage numbers for a moment, it is clear that mechanisms to facilitate the exchange of crypto are critical to enable adoption growth. Centralized exchanges are dominating the fulfillment of that need right now, but both centralized and decentralized approaches will have a place in providing that functionality as consumers decide the tradeoffs they are willing to make for liquidity. As further proof, peer-to-peer trading is tremendously common in sites like LocalBitcoin and HodlHodl and informally throughout the crypto universe in Telegram, WeChat, and Reddit groups. Both institutional and retail token investors currently need and will increasingly seek ways to exchange assets. Thus, using the traditional market fit lens that many project founders consider, decentralized exchanges look like a huge opportunity with an unmet need.

Incentives & Token Economics Are Still Being Ironed Out

The incentives for market makers and takers to participate in an exchange are relatively well understood and crypto exchanges have shown over and over that they can design approaches (such as FCoin’s trans-fee mining) that attract traders to their exchange. However, the long-term token economics design and incentive structures have yet to be fully worked out to ensure continued liquidity and trade volume, especially for DEXs. As a result, centralized exchanges benefit from a fee-based business model that does not rely on native token value to provide liquidity and attract users. As decentralized exchanges continue to experiment with the right token design, it is only a matter of time before the combination of smart incentives and monetary policy is found.

Overall, I believe we are still at the very beginning of determining how crypto exchanges will function in the marketplace. As token-backed assets grow in number, they will need an exchange to find liquidity. As the long-term importance of token economics grows and proven incentive models take root, decentralized exchanges will better attract users. And as mainstream audiences better understand crypto and token value, all exchanges will be at the leading edge of onboarding these new retail investors. To me, all of these trends converge on a healthy competitive market in which centralized and decentralized exchanges are battling it out for share of liquidity.