DeFi derivatives: on the challenges of overtaking the CEX market

William Peaster
Feb 04, 2022
|6 minutes read

The crypto derivatives industry is among the fastest growing sectors in the cryptoeconomy. 

These financial instruments, which help traders flexibly speculate on and hedge against crypto prices, are traded on centralized exchange (CEX) venues or through decentralized “DeFi” protocols

That said, for a DeFi derivatives platform the ultimate goal is to provide a user experience (UX) for traders that is safe and easy like a CEX, while also providing decentralization assurances that CEXes can’t match. 

Indeed, at the end of the day, a CEX like Binance can shutter your account or prevent you from trading, whereas a DeFi options platform like CompliFi cannot because it’s decentralized and head-less.  

However, DeFi platforms aren’t ready for the limelight just yet. DeFi derivatives projects will have to overcome a series of contemporary challenges if they’re ever to overtake their CEX counterparts for good. 

The challenges today

To understand the pain points that young DeFi derivatives projects are working to overcome, let’s compare how these decentralized platforms currently stack up to CEX trading venues. 


As of late, transaction congestion has made gas prices prohibitively expensive for many users, particularly ones trying to open or manage their derivatives positions on the Ethereum L1. This has led to an exodus of projects migrating to “layer-two,” or L2, Ethereum scaling solutions like rollups. 

In contrast, a CEX manages trades off-chain and thus doesn’t face the on-chain scalability issues that early DeFi derivatives platforms have been plagued with. In this regard, CEX trading can be considerably less expensive for now because it avoids gas prices. 


Lately, the DeFi derivatives scene has experienced a Cambrian explosion of new projects and new innovations. This has led to liquidity fragmentation, as dozens of protocols are now competing for liquidity not only on Ethereum but in a multi-chain environment as well. 

Traders will struggle to easily trade in DeFi if liquidity continues to stay fragmented. As for CEXes, they’re typically centralized and popular liquidity hubs, so fragmentation isn’t a problem they face.


Many DeFi derivatives projects require traders to fully collateralize their positions. The problem with this dynamic? It’s limiting. In the context of TradFi and CEX venues, it’s common for most derivatives positions to be only partially collateralized


A CEX is a centralized business. And while a CEX may rely on regulatory arbitrage maneuverings, all have various regulators and jurisdictions they have to answer to. For example, if you run into a problem trading derivatives on FTX, there are various channels you can go through in an attempt to address the issue. 

In contrast, DeFi platforms are software protocols that are specially designed to run without intervention from intermediaries. They can exist and be deployed without clear public management, so accountability is much more ambiguous for DeFi projects

General UX

A CEX venue offers UX that is familiar and straightforward for people who are acquainted with derivatives trading. Conversely, to use a DeFi derivatives platform a user must familiarize themselves with a range of additional crypto-native subjects, like wallets, fee markets, and so forth. 

The UX of a wallet like MetaMask can be jarring for crypto novices!

The opportunities ahead

CEX and DeFi derivatives platforms are helping the cryptoeconomy mature by offering traders more advanced resources for speculation and hedging. 

Both these types of platforms will co-exist for the foreseeable future, to be sure, but will one side eventually win out? I think so

Longer term, CEX derivatives exchanges may see the majority of trading demand shift to innovative on-chain products, e.g. the automated crypto-structured products of Ribbon Finance. Especially as we’re starting to see innovations like Opyn pivoting to partial collateralization, i.e. greater flexibility for users. 

In this case, we may see such CEX venues in some instances transition to providing front-end services that rely on DeFi products “under the hood.” 

For that to happen, however, DeFi derivatives exchanges will need to address gas prices, capital inefficiencies, and UX in general. 

The good news is that virtually all DeFi platforms are currently transitioning to layer-two (L2) scaling solutions, where transactions are rapid and inexpensive and where considerable amounts of DeFi capital will migrate to in the years ahead accordingly.

These L2s come in different shapes and sizes, but overall these solutions are where DeFi derivatives projects hope to beat CEX venues in the years ahead. The idea here? To provide comparable or better UX than a CEX but via decentralized on-chain products on L2s. 

Here, consider the case of dYdX, which uses an off-chain orderbook combined with on-chain execution on an L2. This reality gives the platform the best of both worlds: an easy and familiar trading UX combined with superior decentralization assurances!

Also by DeFi Pulse:

The way forward

Will DeFi beat the CEX arena and become the premier home for crypto derivatives trading going forward? Well surely it may take a while for DeFi to win out, but things are already beginning to trend in that direction now. 

Indeed, there’s no question that we’ve seen an explosion of compelling innovation around the DeFi derivatives ecosystem in 2021. It’s been a year filled with new projects arriving, new products launching, and new L2 integrations going live. 

Additionally, the scene appears to be picking up steam lately. For instance, consider how in the coming days the CompliFi team is launching the V2 version of their derivatives protocol. 

CompliFi V2 will offer traders considerable flexibility on maturities and strikes and introduce perpetuals. Combine these advancements with CompliFi’s deployment on Polygon and the protocol’s eschewment of liquidations, and you have the makings of a project that can out-compete CEX venues over time. 

All that said, the way forward for DeFi derivatives projects is precisely this roadmap: release useful, unprecedented products on L2s where traders can make many trades affordably and quickly. And the more DeFi protocols that follow this roadmap, the better the chances are that DeFi becomes the dominant home for crypto derivatives trading action over CEXes. 

Disclosure: We’ve partnered with CompliFi to help educate and inform the community about derivates. As always, we’re committed to providing the entire community with quality, objective information, and any opinions we express are our own.