Binance, Coinbase take turns watching Layer 2: Why does CEX want to 'marry' with DEX?

The decentralization trend of the largest centralized exchanges means that every CEX needs a DEX.
Recently, BNB Chain released its Layer 2 testnet, an Ethereum Virtual Machine (EVM)-compatible blockchain based on Optimism's OP Stack. Developers expect the opBNB testnet to reach speeds of 4,000 transactions per second (tps) with a fee of 0.005 cents USD per transaction. This speed is similar to the speed on blockchains like Arbitrum, double BNB Chain and significantly higher than Ethereum's 30 tps.
Early on, Binance recognized the importance of building its own decentralized blockchain and DEX. Earlier this year, Coinbase also announced the launch of a Layer 2 blockchain called Base. This trend shows that CEX exchanges need DEX.
In the past, CEX exchanges have lost billions of dollars from consecutive attacks: hacking from outside (Mt. Gox), misuse of internal funds (FTX) and most recently, repression by the law ( Binance and Coinbase). Meanwhile, DEXs are less affected by these three factors.
Of course, CEX is still important for users who do not want to self-custody and for operators who need to comply with jurisdictions. To meet those needs and combat threats, CEX now needs to “marry” with DEX. Specifically, they need smart contract layers that can be put on-chain as the backend for the centralized frontend.
This need is emerging as new interoperability infrastructure makes the “marriage” between CEX and DEX possible.
History of DEX & CEX
The first DEXs appeared within months of the Mt. Gox came to light. DEX quickly became popular as it helped users keep their assets safe and stay away from CEX - which is considered an easy prey for hackers. Indeed, according to data through 2020, external attackers pocketed more than $15 billion from Mt. Gox and subsequent generations of CEX. However, the successor CEX exchanges also gradually matured and hacking incidents decreased significantly. Today, CEX nominally processes 10-100 times more volume than DEX.
Of course, besides hacking, there are other threats. FTX collapsed after regulators mixed user assets and lost billions of dollars in customer funds to Alameda Research. And yet, Binance and Coinbase, the two largest exchanges, are constantly being criticized by the world's most powerful financial regulator.
Meanwhile, DEX provides a shield against three threats: hacking, fraud and regulatory violations. And for the first time, they also compete on a feature that has set CEX apart to date: the ability to trade any token from any chain.
Binance and Coinbase have recognized this and are actively developing their own decentralized systems. The moves of these largest CEXs show: DEXs are not necessarily competitors to centralized exchanges; they are the perfect complementary piece. This is why every CEX needs a DEX (and vice versa).
Secure DEX, easy-to-use
CEX Decentralization makes the system less likely to fail and less vulnerable to attack. This is the principle that motivated the creation of the Internet's earliest iterations - in an effort to make computer systems resistant to nuclear attack. The longevity and reliability of the Bitcoin and Ethereum systems are also testament to the robustness of the decentralized approach.
In general, DEXs are more powerful than CEXs, but history shows they cannot compete with CEXs on features - like trading tokens issued on separate blockchains. However, interchain infrastructure improvements have now allowed DEXs to do just that and process transactions faster by scaling horizontally.
However, it may be that the core feature of DEX - decentralization - has kept many users away. Not everyone wants to manage their private keys. Therefore, whether measured in users or USD, widespread crypto adoption will not become a reality without centralized exchanges.
DEX is transparent, CEX complies with the law
Before its tragic collapse, FTX was one of the most successful centralized exchanges known to many people. The problem is, users have no way to verify how FTX is using their funds. They sent money to trade, make profits... but the money was "gambling" and lost.
Meanwhile, with DEX, transactions are published on-chain. Users can verify the integrity of deposits and see where they are being used. Funds sources can still be mixed, but it's harder to hide that fact from users.
Not every transaction needs to be recorded on-chain. But a DEX running on the backend can periodically show where coins are stored and how they are used. And users can verify their funds are safe using block explorer.
However, on DEXs, integrating off-chain information can be difficult, requiring complex and fragile oracles. On centralized exchanges, this is not a problem. They can easily handle KYC and anti-money laundering processes, select tokens for listing, and apply various filters according to regulations in their jurisdiction. Thus, a CEX working with a DEX on the backend can build multiple user interfaces to serve different jurisdictions.
DEX + CEX: freedom within the framework
Since its inception, crypto has been seen by users and creators as a way to combat potentially abusive governments. Many governments have blacklisted Bitcoin addresses, confiscated Bitcoin warehouses, and spied on users - but none have yet succeeded in stopping the network.
Likewise, any backend DEX that inherits Bitcoin's properties cannot be stopped. Such a system is never monitored, i.e. there is no gatekeeper. This is why Bitcoin is used for both good and bad: from dissidents to criminals.
For centralized exchanges, a decentralized backend performs the same function: ensuring users that no matter what government officials do to the exchange operator, the processing systems transaction management remains beyond their reach.
Composability, interoperability and horizontal scalability
For many true crypto enthusiasts, decentralized exchanges have always been a dream: cryptocurrencies are decentralized and run on decentralized systems.
However, in every wave of crypto enthusiasm, CEX has always served as the starting point and primary interactive experience for the majority of users. There are two main reasons:
1. With a database to process transactions, CEX provides greater and faster throughput.
2. Similarly, an intermediary database makes it easy for CEX to list token pairs on different blockchains. Meanwhile, DEXs are limited to trading pairs of tokens on the same blockchain. Trading a pair like ETH-BTC is impossible.
However, improvements in blockchain interoperability have changed the game for DEXs on both of these factors. Interoperable networks like Axelar that handle General Message Passing between blockchains have allowed DEXs to offer cross-chain swaps.
On the backend, the same cross-chain capabilities mean that Web3 application types of all kinds are now horizontally scalable. DEXs are avoiding congestion by building “appchains” specifically for their throughput or by choosing chains with the fastest throughput. These setups can now connect to users, assets, and applications hosted on other chains.
Interoperability paves the way for continued horizontal scaling: applications can migrate to newer and faster blockchain technologies as they emerge, without requiring users to migrate to chains new.
Finally, and perhaps most promising, a DEX backend allows CEX to combine with other builders, integrating features and network effects into new “superapp” products. Overall, blockchain infrastructure is quickly reaching a point where building decentralized applications is no longer a matter of principle, but a matter of competitive advantage and ultimately - survival.