A DEX or decentralized exchange is a blockchain based market whereby the exchange does not rely on a third party to process a customer’s deposits or withdrawals. Instead, via an automated peer to peer system trades occur directly between the two interested parties. There are several ways that this can be achieved with current solutions ranging from creating proxy tokens (a crypto asset representing a fiat or cryptocurrency), creating assets (that can represent stocks and shares) or through an escrow system with multiple-signatures. Other solutions are currently in development.
Until recently almost all crypto trading occurred on centralized exchanges. Binance which is currently the world’s largest centralized crypto exchange expects profits to reach $1 billion this year as did its rival Coinbase last year. With such huge sums of money at stake decentralized exchanges represent a huge threat to these crypto giants and are destined to fundamentally change the way we transact crypto.
Decentralized exchanges differ from current models which are centralized. With the centralized model, users deposit their funds with an exchange, an IOU is issued which is then freely traded within the platform. When users wish to withdraw funds, the IOU is converted back into the cryptocurrency they represent, and it is then sent to the owner.
Decentralized exchanges have multiple advantages over centralized ones. This lies in the trust less nature of the transactions. To complete a trade, you do not have to trust the integrity or security of the exchange as funds are held in your own personal wallet and never touched by a third party.
Increased privacy is another advantage for users of decentralized exchanges. Users of such exchanges are not required to reveal any of their personal details unless the exchange involves moving funds to a bank account, in which circumstances that information is only revealed to the entity you are buying from or selling to.
The unregulated nature of centralized exchanges means that they can manipulate the market as they please and users have no way of asserting whether they are being treated fairly or not.
In addition to this, as the hosting of a decentralized exchange is distributed throughout all the nodes on the network there is no risk of downtime on the exchange.
Decentralized exchanges are not without their downsides. There are multiple reasons why centralized exchanges are popular. Bitsquare, a decentralized exchange requires you to be online for an order to be listed and for the trade to take place.
In addition to this, certain trading features such as margin trading, lending and stop loss orders are unavailable on most decentralized exchanges as they currently only allow the basic exchange of cryptocurrency at a predetermined value.
Most current implementations of DEX’s have no automatic buyer/seller matching meaning you have to manually agree to each trade. Often multiple confirmations are required by both sides as the sale progresses. This can create an issue whereby both users have to be online for a trade to complete.
As most DEX’s are built upon the Ethereum network they are subject to the time limitations caused by the Ethereum blockchain. This means, for the time being, that high frequency trading is not possible in a truly decentralised environment. Some decentralised exchanges have come up with solutions to this which involve trades taking place outside the Ethereum network on a centralized aspect of the exchange. These trades are periodically brought back on to the Ethereum blockchain.
DEX’s have some way to go until they are comparably functional and easy to use as todays centralized exchanges. However, there are projects that are already offering alternative ways to trade cryptocurrencies, that are already offering basic functions whilst ensuring funds are kept safe from inside thefts, hacks and bad business models.
Bitsquare is an open source DEX where users can buy and sell cryptocurrencies and fiat money without entrusting funds to a third party. The transactions take place directly between the buyer and seller. This is done using a multi-signature escrow system to ensure honesty. The order book is hosted by the user. This means for an exchange to even begin both users must be online. Also, both the buyer and seller have to signal certain actions during the trade for it to complete, this means that not only must the computer be online, but the trader must also be present for the trade to be successful.
Bitshares is a decentralized platform that uses its own native currency known as Bitshares or BTS. When using the platform, users can trade their BTS for Market Pegged Assets (These are various crypto assets that are pegged to another commodity or currency price and are always at least 100% backed in value by the Bitshare core currency). There are also User Issued Assets. These are crypto assets that can be issued by anyone representing shares, commodities and currencies. A web-based version of Bitshares is called Openledger and runs on the same blockchain.
There are several new interesting decentralized exchanges currently in development that will bring with them the ease of use and advanced features that are missing from current implementations. Some of these are the Waves Asset Exchange that allows users to trade assets (encompassing asset-to-asset exchange), fiat tokens and cryptocurrencies. EasyDEX is built on the Bitshares platform and will allow users to trade crypto directly without the need to resort to proxy tokens. The Pegged Asset Exchange is being developed by the SuperNET and Komodo teams allowing users to exchange fiat currency using zero-knowledge proofs to provide privacy.
The examples cited above are just a few of the efforts being made by the crypto community to address the immense need for decentralized exchanges that will put users back in control of their funds and prevent a lot of the issues with centralized exchanges. The future of crypto exchanges is bright, and the future of exchanges is almost certainly decentralized.