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A fleeting glance at market metrics would make it seem that decentralized exchanges (DEXs) spearhead the DeFi revolution, proffering trading platforms that ensure security, transparency, and self-custody. Still, despite their ideological appeal of anonymity, complete decentralization and the like to many users, DEXs bear an inherent Achilles’ heel — liquidity.
Liquidity fragmentation across pools is the main obstacle to positioning DEXs as market drivers. Solving this problem could propel DEXs to rival centralized exchanges and significantly shift how exchanges handle custodial offerings, transparency, and user experience.
DEX liquidity struggles to compete
The disparity between centralized and decentralized exchanges can best be illustrated by the amount of actual funds users are willing to commit to either type of platform. The numbers showcase vested trust, as DEX to CEX spot trade volume stands under 20% (per DeFiLlama data) and the ratio of derivative trading between such exchanges was under 5% in the past few months.
Liquidity ensures that trades are executed swiftly and at stable prices, but DEX liquidity pools often swing during volatile markets, causing slippage. This is the case when the executed price deviates from the expected one. For large trades, this can mean losses of 5% or more, preventing the entry of institutional players onto the scene.
DEXs are looking for an answer to their base weakness. They are exploring such use cases as stability pools, compensation packages, and even rewards to retain users and help them feel catered to, even at a loss. But these are rather placebos that do not help DEXs develop or users build trust in them.
Liquidity aggregation: Pooling strength
In unity lies strength, as the adage goes. Based on that, a promising way of solving the liquidity issue is for DEXs to compile resources and share liquidity pools. DEX aggregators use this method to tackle fragmentation by sourcing liquidity from multiple pools across DEX platforms.
This approach allows users' orders to be split across different DEXs and executed in minutes with optimized pricing. On-chain data show that aggregators reduce slippage by up to 30% on large trades compared to standalone DEXs. Yet, elaborate routing increases gas fees and makes aggregators depend on the underlying pools’ depth, which can dry up during bear markets and reduce the potential for adoption.
Cross-chain solutions: Bridging the blockchain divide
The persisting blockchain technology fragmentation reinforces the need to deploy separate liquidity pools for each chain to process transactions. Cross-chain technologies aim to bridge this gap, unlocking the potential of multi-chain transactions and pooling resources to address the liquidity problem.
According to Token Insight data, the top 10 DEXs collectively processed over $2 trillion in spot trading volume in 2024. The same data indicates that the share of DEX trading grew in the 7–10% region at the start of the year to over 20% by January 2025. Such traction depicts the potential offering and use case of liquidity pooling.
However, interoperability often introduces the risk of bridge hacks, decreased efficiency, and latency issues. As Layer 2 networks lower their fees and boost throughput, cross-chain trading could unify DeFi liquidity, making DEXs more competitive.
Hybrid exchanges: The best of both worlds
Hybrid exchanges combine DEX’s autonomy with CEX’s efficiency , offering tighter spreads and rapid order execution, which is particularly important for active traders. These platforms utilize centralized matching engines for efficient order processing. This helps them handle large volumes of buy and sell orders, resulting in higher liquidity and faster trade execution. Once a trade is completed, funds are transferred on-chain, ensuring users maintain control over their assets through decentralized custody solutions.
Typically, hybrid exchanges address liquidity challenges by implementing off-chain order matching, aggregating liquidity from decentralized and centralized pools, and collaborating with market makers. These strategies help to reduce spreads, stabilize prices, and enhance the overall user experience, making hybrid exchanges more accessible to a wide range of traders. dYdX’s case proves how centralized order matching with decentralized on-chain settlement can enable near-instant execution, while keeping all assets secured on blockchain.
Still, the hybrid exchange solution comes with specific risks. The reliance on off-chain components can lead to centralization risks, such as hacks and inefficient governance. Additionally, maintaining stable liquidity can be difficult in highly volatile markets, potentially impacting order execution and pricing.
For DeFi users, the hybrid model offers improved liquidity and faster trade execution but at the cost of compromising some decentralization. Meanwhile, for CEX users, the familiar order book trading mode makes hybrid exchanges more approachable, serving as a bridge for the mass migration of CEX users to the world of decentralized finance.
CEX-backed DEX models
From 2023 to 2024, DEX spot trading volume doubled, and the total value locked surged, driven by Layer 2 network technologies that reduced transaction costs. Despite this progress, DEXs still represent less than 20% of the overall crypto trading volume, with centralized exchanges maintaining market dominance.
A new approach and promising development to bridging this gap is the rise of the CEX-Backed DEX model. This approach combines the strengths of centralized systems with decentralized principles, allowing DEXs to leverage CEX resources like liquidity and user base while giving users control over their assets and data.
Despite their advantages, the CEX-Backed DEXs also come with challenges. They often retain elements such as operational management, which deviates from the decentralization philosophy of traditional DEXs. This hybrid structure may introduce governance inefficiencies or conflicts of interest, posing risks to their long-term sustainability.
Competition requires innovation
DEXs have the potential and tools to overcome their liquidity challenges, but this will require trade-offs. Innovations, such as concentrated liquidity and AI-driven market-making, could help deepen liquidity pools organically. However, aggregation and cross-chain tools are merely temporary fixes.
To address the liquidity issue, DEXs need to start innovating and tapping into options like scalable blockchains, smarter automated market makers (AMMs), and decentralized liquidity incentives. The latter can even compete with CEX market makers, like CEX-backed DEX models, making it a solution to keep an eye out for.
Only technological innovations and creative strategies can present new use cases and enhance the potential for mainstream adoption of decentralized exchanges.
Vladislav Sopov
Dan Burgin