What is decentralized exchange

Decentralized exchanges explained

Decentralized exchanges (DEX) could be the central point of discussion in 2018. Currently, the two most widely traded cryptocurrencies (Ethereum and Bitcoin) are used for millions of transactions every day, including other cryptocurrencies, digital assets, and paper currencies. These transactions are mainly carried out on stock exchanges, which are responsible for maintaining liquidity and securing transactions as well as users. For example, a blockchain system that has been structured to provide a decentralized solution largely relies on centralized switches, which continue to be hit by hacks, poor management and, in some cases, scams.

Decentralized exchanges could be the solution, as they are supposed to be decentralized like the blockchain protocol itself.

Decentralized stock exchanges

Put simply, decentralized exchanges are a network of nodes that essentially contain a wallet with integrated switching options. There is no third party through which funds are transferred during a trade. Transactions are validated and secured by the blockchain and work via a peer-to-peer connection.

DEX advantages

As already mentioned, the advantages of the decentralized exchange include security, democratic administration and the possibility of increased anonymity.

However, DEXs have been around longer than most people think, and they have been tested in a variety of situations. This has resulted in more uses for the technology and a better understanding of the technology by many who will be preaching the usefulness of the DEX platforms in 2018.

The most successful application of decentralized exchanges is the full order book DEX with trading desks that offer a very similar trading experience to the popular centralized exchanges like Bittrex, Binance etc. Bitshare DEX is a good example of such a decentralized exchange and has been in operation since 2015. Although decentralized exchanges do not offer insurance, Bitshare holds 100% or more of the value of its core currency, the BTS. Bitshare claims that the value of a smart coin in "all but the most extreme conditions" is equal to, if not more, the value of the BTS that is tied to it.

The speed of transactions, registrations, account opening, deposits and withdrawals are always a central point of discussion when thinking about which traditional exchange to use. During times of high trading volume, many of the top exchanges face downtime. New registrations have been interrupted and trades, deposits and withdrawals can take much longer than expected. In a decentralized exchange, the burden of all these transactions will not affect the speed and performance of the trades. Peer-to-peer transactions only occupy the two parties involved in trading and the network can support extremely large volumes of trade, making DEX a very scalable solution for the future.

However, one of the most important characteristics of a DEX is the security it can provide for trading. Since information is not centrally stored or processed by third parties, there is no unique node that would be a target for many ambitious attackers. Instead, each user is responsible for the security of their own wallet.

Finally, we have to mention that, in theory, a DEX cannot be regulated or shut down by a government, as there is no central management.

 

DEX cons

Some of the disadvantages associated with DEX, as in the case of the advantages, may be the subject of discussion. Is a central authority better able to make decisions and protect users than a decentralized, consensus-based stakeholder structure?

Society and the financial system are initially tied to regulators, laws, and treaties. When you keep your money in a bank account, you can expect what the aftermath of a bank robbery, bankruptcy, closure or hacking will be. If the bank uses its power, regulators or the law can step in to protect you as a customer of the bank. The same logic has been applied to some of the larger, centralized cryptocurrency exchanges, and governments are becoming increasingly involved in their global administration. However, decentralized exchanges are not insurable, regulated, or represented by anyone who could be held accountable for problems small or large.

The services offered on DEX are also very limited. Margin trading, fiat currency trading (and depositing) and stop losses are usually not offered and consequently lead to a reduced trading volume. If the trading volume is reduced, it can be assumed that the fees will continue to rise. In addition to the fees associated with purchasing the cryptocurrency and transferring it to your wallet, this makes trading on DEX many times more expensive (in terms of fees) than on a central exchange.

It is probably important to also keep in mind that many DEXs do not offer support and if you find yourself in a complicated situation, forums and other users will be your only way out.

Gateways

Gateways were introduced as a solution to the current difficulties users face when depositing paper money in a DEX in order to later trade for cryptocurrencies. A gateway will issue a cryptocurrency which they will pay back to them using the funds from your fiat currency deposit. This cryptocurrency is listed on the DEX that the gateway connects to, and so you can exchange this cryptocurrency issued by the gateway for other coins on the DEX.

You will quickly find that this involves a third party in your DEX transactions, and the cryptocurrency they issue is essentially as valuable as the market sees fit (even if backed by a real asset / security instrument is). In this case, however, the third party is only active in depositing funds in the DEX, initially or until you have made your first trade and keep your funds (new cryptocurrency) in your own wallet.

Atomic swaps

An atomic swap is an exchange between two cryptocurrencies that work on a different protocol, e.g. Bitcoin and Ethereum. A trustless transaction between two different blockchains is what everyone seems to be pursuing right now.

In a DEX environment, atom swapping would be a possible solution to replace gateways.

Major DEX projects

There are many DEX projects that have either started in the last few months or will increase in 2018. Some of the top projects that you will hear more about over the next few months are:

  • 0x
  • OmiseGo
  • Ether delta
  • Waves
  • Altcoin.io
  • Shapeshift.io

You should expect a lot more to come out soon, and of course there are more that are worth mentioning and adding to the list in time.

To sum up, DEX trades are not for everyone at the moment. The inexperienced trader will most likely save fees and find it easier to trade on a centralized exchange. However, anyone who wants to exchange larger amounts of cryptocurrency and is familiar with more advanced storage technologies such as hardware wallets and offline storage could benefit from a DEX platform. In any case, the decentralized exchanges are evolving rapidly and the solutions being applied to the existing problems, as well as the faster adoption by seasoned crypto traders, will make DEX a major topic of discussion in 2018.