Cryptocurrency exchanges have seen a massive growth in numbers over the past year, although, exchanges constantly evolve and improve and there are many challenges ahead.
At the moment, most users join the crypto space via one of the major exchanges as they act as the main entry point. If we want to trade, we mostly rely on centralized exchanges like Bittrex, Kraken, Bitstamp, … However, decentralised exchanges have started to gain traction, as they grow and are able to process more transactions, but the number of transactions per second is still less than centralised exchanges.
Exchange Related Innovation
Decentralized exchanges (DEX) aim to tackle the problems that impede centralized structures by building peer-to-peer marketplaces directly on the blockchain.
Many of those decentralized exchanges use atomic swap technology. Atomic swaps are often called cross-chain atomic swaps, meaning, two different cryptocurrencies that are present on different chains can be exchanged atomically without any trusted third party and there are no exchange or trading fees involved.
To give you an example; Alice wants to trade 1 Bitcoin for Bob’s 10 Litecoins. Normally, she would need to use an exchange to sell her Bitcoins and buy her Litecoins. It’s a slow and costly operation. However, with atomic swap technology, she can trade her Bitcoin with Bob’s Litecoins directly, without paying any (or very low) fees. A hash time-locked contract (HTLCs) is used to prevent one of the parties running away with the funds.
To perform such atomic swaps, it’s required that both blockchains share the same cryptographic hash function, such as SHA256.
- Instant transactions: If there is a sell order that matches your buy order, the transaction will be executed immediately.
- No fees/very low fees.
- Security: Ability to retain your private key as opposed to keeping your private key on an exchange.
- True peer to peer: Atomic swaps allow for peer to peer exchange of value.
- Transparency: It’s not possible to create fake volume.
- Both chains need to support the same cryptographic hash function.
- As an atomic swap transaction depends on both blockchains, one might have to wait for the confirmations to be cleared on one side.
- Transaction fees can inflate for example for BTC to LTC as BTC tends to have higher transaction fees.
- Privacy: As the hash of the contract is shared during the atomic swap process, a third user can easily track the transaction. However, there is no data included that can link an identity to a user.
Another variant to this technology is the Waves-NG consensus protocol which is being used by the Waves DEX. This Waves-NG consensus protocol is a clever selection algorithm.
Think about submitting a transaction to the Bitcoin network. There is no guarantee your transaction will be included in the current block. In case of a large backlog, you may have to wait for several blocks (every block takes 10 minutes to find) before your transaction is included. Waves-NG has come up with a process to optimize this by selecting a miner in advance so that transactions can be added to the next block almost instantly. Using Waves-NG, the only, minimal, delay a transaction may experience is the time it takes for the transaction to be broadcast across the network.
In addition, Waves came up with the idea of ‘micro-blocks’. Micro-blocks contain transactions like normal blocks but can be generated and signed faster. The process of validating one large block is much slower than validating multiple smaller blocks. This results in increased performance and transaction speed.
According to Waves, Waves-NG consensus can reach a throughput of around 6000 transactions per minute (100 tx/s).
Exchanges of The Future – Hybrid
Decentralised exchanges are hot, but for now, they won’t reach the scalability centralised exchanges offer. That’s the reason why Hybrid exchanges are the future. They combine the power of both centralised and decentralised exchanges:
- Fiat integration
- Decentralized security
- Low (fixed) or no fees
- High throughput
A hybrid exchange allows you to maintain total control over your funds that will be managed on a safe and trustless platform. Instead of using a smart contract for the exchange, each account will be based on an Ethereum smart contract where tokens will be placed. This dedicated account is necessary to enable atom swaps, but they also prevent the exchange from having unauthorized access to your funds.
The centralised part of the exchange is the matching engine. This engine is responsible for matching up bids and offers to complete trades. Matching engines use one or several algorithms to allocate trades among competing bids and offers at the same price.
EIdoo is, for example, a project that has built such a hybrid exchange. They completely removed the steep learning curve by offering a simple to use mobile application that allows you to trade instantly.