The birth of cryptocurrency stemmed out from the idea of a type of currency which no one has any control over it. But, as we know, the reality of the crypto landscape is quite a bit different, and this is primarily due to the type of exchanges we have.
The future of Cryptocurrency Exchange seems to be shifting towards Decentralized Exchanges slowly but steadily, and it may replace our centralized exchanges one day, at least that is what most people in the crypto space firmly believe.
We wouldn’t say that they are not completely correct as there are a whole lot of parameters and things to consider before we can say that for sure as well. If the past few years of crypto space, as well as the nature of technology and invention over the century, has taught us anything that it is ever-changing. The transition to the new happens quickly when it has much more to offer than the old, but if both the old and new have something to offer that the other doesn’t, then both co-exist complementing each other, but if there is not much value in the new the old always prevail in the market.
Therefore we think it is obvious that we should carefully observe and analyze the current market, its need, as well as the other factors which can give us an indication of what is the future of the Decentralized Exchanges in crypto space.
Before we go into the market scenario, the future and all, we think it is better if we clear out the type of exchange we are dealing with today. So let’s check the crypto exchange types first.
Crypto Exchange Market Type Available Today
First, we would like you to understand these two terms – Custody and Centralization.
Custody refers to who holds the keys to crypto user accounts on the exchange i.e. who holds your coins. Therefore, depending on custody, exchanges are divided into two types – custodial exchange and non-custodial exchange.
Custodial Exchange – There are exchanges like Coinbase where when you buy a cryptocurrency the coins are added to your exchange wallet, but you neither own those coins nor can access those yet and therefore can not use it. You need to make a transfer request to the exchange to transfer those coins to your external wallet. Once they show up in your external wallet, you are free to use as you please. Therefore here the custody of the account is lies to the exchange itself, like managers of the users’ accounts.
So naturally, if the exchange is hacked or attacked in any way, your coins in the exchange wallet is compromised as well.
Non-Custodial Exchange – A non-custodial exchange, on the other hand, doesn’t have a wallet of their own, instead, leave all the coin in private wallets of users. You need to initiate and complete any trade from your wallet only, thus the exchange act as a matching service platform. So here the custody of your account completely belongs to you.
Centralization refers to where the matching of trade orders, routing, and the execution take place. This allows for two types – centralized exchange and decentralized exchange.
Centralized Exchange – Every exchange of this type have their own order book which receives and reviews all trade orders and matches them accordingly using their own software and servers. In short, the order is processed by an internal closed system.
Decentralized Exchange – Naturally decentralized exchanges, instead of relying on their own servers, operate on a network of computers. To search and match orders, while some exchanges use smart contracts to function directly on-chain, others make use of second-layer networks of trusted nodes called relayers.
As the differentiation is out of the way, now let’s check which type of exchange dominates the market now.
The Market Scenario
Observing the type of crypto exchanges available, in general, we can categorize today’s exchange market in mainly three types –
- Custodial exchanges
- Non-custodial exchanges
- Decentralized exchanges or DEXs
Both the custodial and non-custodial types belong to centralized exchanges, well mostly, while rest are of the decentralized type.
Now let’s take a look at this very informative diagram from Coincentral which gives a clear picture of the market of crypto exchanges today.
As evident from the picture, today all the decentralized exchanges available are of the custodial type with no trace of their non-custodial version as of now.
There is a couple of non-custodial exchanges as well but the number is not even close to their custodial peers. Examples include Shapeshift, Evercoin, Coinswitch, Changelly, Faast etc.
Most of the major exchanges today are custodial as well as centralized in nature, examples – Coinbase, Binance, Poloniex, Gemini etc. According to the stat given by Tom Goldenberg of Coindesk, in May 2018, 99% of trading volume occurred through centralized exchanges, out of which about 73% is the custodial type.
But the scenario has changed since then, even though just a bit. According to the data provided by Brainwave.com decentralized exchanges account for just 2% of the total trade volume, while the rest is handled by centralized exchanges. Binance, the world’s largest exchange by trading volume is a centralized exchange, which handles more volume in 24 hours than Bancor and Waves handle in 30 days.
For some people, the focus towards a custodial exchange is expected since by definition an exchange is a single point where people meet to trade thus allowing for transactions to happen quickly. However, for others, the whole idea of building the future of decentralization of currency atop centralized exchanges beats the very objective of decentralization.
So, let’s check what kind of benefits and challenges custodial exchanges present.
The main reason the majority of exchanges are Centralized today because these are user-focused. These exchanges are very easy to use, have a much lower learning curve, and offer better liquidity for their crypto coins.
Since the people who run the exchange are there for profit these more client-focused, and therefore usually have a dedicated support team for users. For better user experience they keep adding more features regularly as well as updating them. And undeniably because of the profit-making nature and service they bound to have a certain level of accountability to solve any issue.
Next, we discuss the issues associated with custodial exchanges, which applies to most centralized exchanges as well.
Concerns with Custodial Centralized Exchange
While custodial exchanges take away the custody of your coins, it also means that they are liable to protect your fund, not you. The biggest advantage it offers in return is the ease of use. Instead of securing a private key, which can be a tedious job, you can access your wallet (i.e. your account wallet in the exchange) by simply authenticating with your username and password.
But, since most of these custodial exchanges are centralized, this coupled with the immature state of regulation has raised some serious concerns. Once a hacker gets hold of the private key to the exchanges, they can wipe out funds of its users. As per statistics, one in every 16 Bitcoin gets stolen from this type of exchanges. Since then these exchanges have employed a cold storage system as well to keep the bulk of these funds there, but the fault remains.
Aside from hack, there is another problem associated with these exchanges. Since these type of exchanges hold your money, unless you withdraw that, it is worth nothing. So if a certain government like the US, China or Japan shut such an exchange down then your entire pile of crypto coins locked in that exchange is gone completely as well, forever. A great example of such a case in the government shutting down Mt. Gox.
Then there is the concern over price manipulation in exchanges as reported in the recent probe by the Department of Justice, which leads to the next problem. Exchanges like Bitfinex (custodial and centralized) have been accused of market manipulation and there are cases of embezzlement on three South Korean exchanges.
Then there is the threat of Exchange Run issue – a scenario where more people withdraw from the exchange than the exchange has the monetary capability to pay it. This is a problem for some popular stablecoins including Tether which needs to have a solid backup to operate. Tether, which backs Bitfinex, needs to have $2.2 billion in liquid fiat assets in exchange to back its supply.
There is a long history of such hacks that wiped out quite a lot of user funds.
In 2012, 46,703 BTC were stolen from Linode exchange wallets due to an inside hacking. In 2014, Mt. Gox’s exchange wallet got compromised (which turned out to be an inside job) and as a result 850,000 BTC were stolen with the current value of about (7000 USD at that time) 5,950,000,000 USD.
In 2014, hackers were able to exploit a faulty withdrawal code of Poloniex exchange due to which it suffered a loss of 12.3% of its Bitcoin storage. The Bter exchange wallet hack cost the exchange a loss of 7,000 BTC stolen in 2015. Bitstamp’s wallets got comprised in both 2015 and 2016, resulting in a loss of 19,000 BTC and 18,866 BTC respectively. Next is the 2016 hack of Bitfinex wallet where 119,756 BTC were stolen.
This year in January, CoinCheck has lost $534 million worth of NEM coins to wallet hacking. The latest to join the list is Bithumb which lost $30 million worth of crypto to hackers in June 2018.
Another issue with a centralized exchange is its higher fees. Because firms run them for profit in exchange for their service, the conversion rate is not always great (a large user baser takes the competition off their shoulder) and the various fees associated with trading and other services can get quite high depending on market activity.
Therefore, in short, custodial centralized exchanges have the following points going for and against them
- Easy exchange of fiat to crypto
- Offers Familiar interface
- Better customer support
- Easy target for hackers – a single point of attack
- Demands high fees
- Lack of privacy
Now let’s check the non-custodial exchanges.
When we are talking about this type of exchanges, these are always centralized type (refer to the picture). Therefore, instead of managing user wallets, non-custodial exchanges have their own order books which they use to match trade orders of users and take a fee for that service.
So what are the advantages non-custodial exchanges offer?
Since the users hold their own money, not the exchange, you as a trader will always have access to your funds. This also means that these exchanges offer better privacy and more security. Another advantage they enjoy is they require lesser security support than custodial types.
Users deposit their coins into smart contracts which do not have private key, therefore it is very unlikely for any hack to happen, thus avoiding counterparty risk. So non-custodial exchanges are regarded in crypto space as the most secure trading platforms.
But there are drawbacks as well. Besides now you have to take care of your funds, there is little to almost no customer service available for these type of exchanges. Non-custodial exchanges do not offer the facility to convert fiat currency to cryptocurrency. This has prompted several efforts to peg a cryptocurrency to the dollar.
As mentioned earlier, since all non-custodial exchanges are centralized, their internal mechanics i.e. how they are run internally i.e. are not transparent, thus implying the possibility for internal manipulation. These type of exchanges have comparatively much fewer coins listed resulting in many traders and sophisticated investors shying away from this low liquidity issue.
Shapeshift is one of the most popular non-custodial exchanges examples, According to its founder Eric Voorhees, the exchange has a daily trading volume of $10 – $15 million in average processing about 15,000 orders daily.
So, in short, the non-custodial exchanges offer the following advantages and disadvantages –
- Much better security as there is almost zero chance of a hack
- Users have access to their funds all the time
- Almost non-existent customer service
- Low liquidity level
- Security depends on your third-party software and services
- Unknown internal mechanics
What the word Decentralization refer to on an architectural level is that there is no centrally-controlled server, and the nodes of the network are distributed.
Now, there is four core functions to every exchange – capital deposits, order books, order matching, and asset exchange. Now, if you want a fully decentralized exchange (DEX), then each of these functions has to be decentralized. But in cases of most exchanges, only the asset exchange part is made decentralized, while the rest three functions, especially the capital deposits function, are usually kept centralized. This is done due to the fact that crypto coins exist on the blockchain and therefore there is no control of central entity over it.
If you want the truest example of a decentralized exchange available in crypto space today, then there is probably no better example than the Blocknet “BlockDX”. This is the only one that has decentralized all four functions.
Types of Decentralized Exchanges
There are two types of decentralized exchange models exist based on the way they transact currencies – currency-centric and currency-neutral. Note here that both of them can be centralized or decentralized, based on how the exchange in question handles those four key functions.
The currency-centric exchanges are built on top of a single blockchain platform like Ethereum. The traditional exchanges are built like this. This type of exchange can only escrow those currency(s) that belongs to the platform it is built on. For example, an exchange based on Ethereum can only escrow ERC20 assets and other related contracts.
The currency-neutral model is rather new. This exchange type is engineered to connect different native cryptocurrencies, so there is no need for users to abide by any specific cryptocurrency ecosystem. These exchange types allow you to trade cryptocurrencies without a coin underlying that exchange, which acts as a kind of an additional “middleman” to go through since it is no longer fully peer-to-peer transaction. Example of the currency-neutral exchange type includes altcoin.io, Bisq, and flyp.me.
These new model not only allow for asset exchange but also for securely matching and handling order books in a decentralized manner using the blockchain.
An exchange hosts a community of users, therefore there has to be a way to broadcast and match orders. One way trustless trading is done is through the use of atomic swaps for order matching. But it is done from one peer to another and the two-way transaction happens at the same time. Since it cannot be used for broadcasting, atomic swap alone is not sufficient to create this type of trustless marketplace.
To make you understand the opposite of atomic swap would two separate transactions, one after the other is made, not at the same time. Therefore to create that trustless marketplace smart contracts act as a trustless escrow holding onto one currency until the other party sends their fund, and then only both currencies can be released.
Advantages of Decentralized Exchange
- Anonymity –
Before allowing you to trade, most centralized exchanges ask for a lot of your private information like your name, id, bank account number etc. to sign up for your exchange account. To comply with government regulations anonymous crypto-to-crypto exchanges additionally asks for your location information as well as other personal details.
But, Decentralized exchanges use blockchain information to operate and therefore, in the ideal case, only need your public address. As of now, contributing in only a small percentage of entire crypto trading volume, DEXs doesn’t come under any government regulation (though the idea of decentralization is to be out of the control of the government or any central body). But that being said, as the paradigm shifts in favor of DEXs, they can face regulations. However, most of the creators of DEX can avoid the KYC and AML issues by saying that they have only released open source software and therefore they can not be held liable to what the community does with it. But, if there is any badly written smart contract or any security flaw in the code itself, the scenario is different. And how much this argument will hold legally long term is up for speculation.
- Censorship Resistance –
Following up from the previous, decentralization thrives on the idea that nobody can control it. Unlike a centralized exchange, the government neither can track the transactions or put a tab on it, and nor can forcefully impose any taxes or other regulations on i decentralized exchanges. They cannot even ban any or the exchange itself, as is the case with countries like India and China where their government has banned crypto exchanges, with countries like Russia, Mexico, Brazil, and Saudi Arabia restricting the use of crypto coins.
- Security –
In a decentralized exchange, every user is completely in charge of their own funds and hold their very own private keys. So unlike the central exchange, there is no central control or point of attack, and therefore cannot be attacked or manipulated, well unless the hacker is willing to spend substantial resources to gain very little.
Note here that there are many DEXs who claims to be decentralized, but in reality are of the hybrid type. Let’s take the example of Bancor here. When Bancor got hacked and lost $23 million worth of crypto asset in the process, the exchange the exchange froze those assets – a feature built into their protocol. This capacity to freeze assets is only available with at least a partially-centralized architecture.
Moreover, this type of exchange exists across a network of computers, therefore it is much more complicated to attack. What this means is there is no single point of entry or failure and as therefore as the network grows, DEXs get more secure. But this also makes DEXs much more difficult to design and test, which is one of the reasons why DEX development has experienced slow development.
- Privacy –
The big exchanges have been under heavy DDOS attacks. The primary advantage DEX offers is privacy. DEX doesn’t offer their own hot wallet, instead, the user can choose other hot or cold wallets and so has complete control of their personal wallet, thus removing their personal information from the hackers.
- Downtime –
In DEXs there is no single point of failure, meaning even if one node or multiple nodes go down due to attack or maintenance work, rest of the nodes of the DEX will keep it up and running. This vastly the downtime of the exchange as well as make the rollout of updates easier, which, by the way, happens on a node-by-node basis.
- The potential for Higher Transaction Speed and Lower Cost –
DEX doesn’t need any third party authenticator and hence has the potential to offer faster transaction at a reduced transaction cost. But this is currently theoretical as DEX need to reach a certain level of network population called critical mass to make this happen.
- The potential for Benefitting Larger Trade Volumes –
With no centralized server keeping any critical information including user funds, hacking is completely out of the picture. This makes DEX a better choice and practical for trading large volumes, but, as explained in the drawback section, the scenario currently is a bit different
- Adoption of New Digital Assets –
Most of the top centralized exchanges charge a high fee for listing new coins. These listing charges are ineligible in case of decentralized exchanges, therefore it presents the opportunity to firms to enlist their digital coins without the initial costs thus driving the likelihood of its growth.
- Reduced Fee –
Another advantage of DEX is it needs very less money, compared to centralized exchanges, for maintenance. Since there is no need to offer a hot wallet to the users, the cost is brought down substantially. Decentralized exchanges do need money to sustain themselves, but that can be collected from charging a very low fee each time a user transact, thus abiding by the original idea of the blockchain.
Disadvantages of Decentralized Exchange
With so many advantages of DEX, it has its fair share of disadvantages as well. Creating a decentralized exchange in inherently much more complicated, so is its implementation and usability.
- Usability –
The major factor that stands in the way of the adoption of decentralized exchange is its usability. The user interface and navigation are much more complex here, so much so that, it may make a beginner frustrated and finally give up. Creating an account in a centralized exchange is a straightforward business like opening an account in a bank and operating. Compared to the centralized exchange where a beginner can start trading since the first day and can navigate through the exchange almost on their own, this cannot be said about DEXs.
The things a beginner need to do before they can start trading includes connecting to a DApp (decentralized applications) as well as installing a stand-alone DEX client on their computers. To give you a perspective how complex it can get, on the best case scenario all you need to do is set up a MetaMask wallet, fund it with the digital assets, connect with an Ethereum-based DEX DApp, and you are done. In case of the most complicated DEX, to sign transactions you may have to set up an independent node and then stay online for hours.
- Lack of Functionality –
There is not as much functionality present in DEX as their centralized counterpart. Most Decentralized exchanges support only the basic market functions i.e. buy sell and a few more, thus just a few simplified trading tools. It leaves out helpful centralized exchange features like margin trading and stops loss. On paper, there is a lot of ambitious functionality mentioned and a few planned, but the technology has simply not been able to catch up with it yet. One thing to mention here though is there are a couple of DEXs like BlockDX which are planning to support additional features.
- Low Liquidity –
As mentioned earlier, DEXs represent only about two percent of the trading volume of the cryptocurrency market. And the number of coins listed on these exchanges are comparatively much lower, you will find only a couple of most popular ones. This means there is not enough liquidity to make high-volume trading, just low volume trading of popular coins is possible at the moment. Also, there are no centralized institutions providing market maker services.
- Latency –
Crypto market is volatile and so the price of the digital assets keep changing every minute sometimes even on seconds. So for trading, it is essential that you want your transactions or trading to occur as fast as possible, ideally instantaneous, otherwise, you are likely to miss on a price and therefore fail to make a profit. For DEXs all transaction requests have to go through the decentralized network which takes time, thus increasing the order processing time and much slower cancellation time so far, resulting in price slipping, where price changes between order time and execution time, a common issue.
- Front-running –
In order to execute a trade, you always have to broadcast your intentions to the entire network, and therefore there lies a possibility that there are some bad actors present on the network actors can jump ahead of you in line with their with faster connections speed and buy up crypto coins at a lower price. Now they can sell those same coins back to you in a higher price This practice is known as front-running which corrupts the fairness of the exchange. There’s no real way on decentralized exchange to make sure that no miners or relayers can jump in line for buying orders. Though there are some DEX creators who are working on some potential solutions for this involving signatures or collateral, there is no solid solution exists as of now.
6. Slow Transaction Speeds –
For DEX, there is no central authority and validation is required on blockchain for every transaction. Depending on the type of blockchain the exchange is using it can take various time, to transfer coins or canceling an order. Therefore the transaction speed is limited by the type of blockchain the DEX uses and no control over it yet.
7. Expensive –
There are some decentralized exchanges which may use gas thus making block confirmations much costly. This will increase the overall cost per trade thus disabling the primary motive for users to use crypto.
8. Lack of Fiat Support –
As mentioned earlier, decentralized exchanges do not abide by the KYC and AML regulations. DEXs only have support for crypto to crypto conversion, there is no support for crypto to fiat conversions or vice versa, as this would introduce a point of centralization. Instead, users must use cryptocurrency deposits.
There is another problem with DEX we would like to draw your attention to. To facilitate transactions (like using it as an escrow for peer-to-peer transactions), DEXs make use of smart contracts. If we can ensure these contracts are highly secure, then the exchange gets benefited from the cryptographic security of the underlying blockchain.
But often that is not the case. Smart Contracts may have quite a number of vulnerabilities, including overflows, underflows, reentrancy attacks, and others – as per numerous studies, there are currently about 34,000 contracts with known vulnerabilities today. These facts and the recent hacking incident with exchanges such as Bancor point towards the necessity of mart Contract Auditing in order to verify the security of the contract code as well as find any back-door vulnerabilities present in it.
A Summary of Comparison Between CEX and DEX
|Features||Centralized Exchange (CEX)||Decentralized Exchange (DEX)|
|Trade volume||CEXs offer higher trade volume than DEX’s Some people believe that around 90% of the total trade in cryptocurrency takes place in CEX.||Trade volume is much lower than that of CEX as they are difficult to use and are limited in their functionality.|
|Liquidity||CEX’s have higher liquidity.||Liquidity of DEX’s are very low and not enough to compete with that of CEX’s|
|Fiat/crypto exchange||A few CEX’s allows its users to buy cryptocurrency with fiat currency and vice versa||DEX’s offer no such facility|
|Options for Direct fiat currency payments||Most CEX ‘s allow bank transfer as well as debit and credit card payments for fiat currency payments||DEXs offer no such facility as it accept only cryptocurrency|
|Immune to Hacker Attack||CEX’s are not immune to hacker attacks||Due to its distributed structure, DEX’s are more immune than CEX’s|
|Risk of infrastructure downtime||This depends purely on the infrastructure of the CEX||Due to its distributed nature, there are virtually at no risk of suffering from infrastructure downtime|
|Risk of getting shut down by the government||Many Governments have banned CEX’s||No chance of government intervention as its distributed|
|Level of privacy||Low level of privacy as users are required to provide sensitive data like bank account details and government issued ID’s.||Very high level of privacy. All transactions are anonymous. Level of privacy is very high as all transactions are anonymous.|
|Functionality||Most CEX’s offer large number of functions, from margin trading and high volume discounts to advancing charting system.||DEX’s on the other hand offer limited functionality in order type or have fewer coin listed|
|Popularity||As they are user-friendly they are quickly becoming popular||As they lack simple user interfaces they are less popular than CEXs|
|Legality and regulation||Most of the CEXs are licensed and are getting regulated by the government institutions||Free from government control and interference|
|Transparency||Most of the CEXs publish their ownership details as well as their office location, servers etc as they are licensed by the government||DEXs are decentralized and thus have no formal location|
|Insurance of the accounts||Many CEXs get their users accounts insured so that if something goes wrong then they can get their money back||DEXs don’t offer any insurance facility|
|Additional services||Some CEX’s offer additional services like banking, cryptocurrency debit card, digital wallets etc. These additional services are very useful for users and allow them to buy goods and services online||DEX typically do not offer additional service|
|Transaction time||Depends on the exchange||Depends on the exchange|
A Few Examples of Top DEXs
Let’s now check out a couple of top decentralized exchanges available in the market –
IDEX is one of the most advanced and the first Ethereum-based decentralized exchange. It currently has $1.28 million of 24-hour trading volume i.e. 257.87 BTC. IDEX is capable of maintaining real-time trading and a high transaction throughput. The off-chain trading engine of IDEX and smart contract features together makes it a protected and quick trade execution platform. Soon after launch, it has quickly made a name for it.
It currently supports trading of only Ethereum and ERC-20-based token pairs including well-established coins like OMG, REP, BAT, and ICX as well as newer coins like MKR, CPC, TOMO, and HAV. But despite being a decentralized exchange, it supports about 445 cryptocurrencies – quite an impressive number.
Let’s see what IDEX has to offer.
Functionality – The IDEX platform uses a simple but well-designed interface and incorporates features such as TradingView charts and encrypted wallets. IDEX provides a comparatively fast and user-friendly trading experience. Alongside an Ethereum smart contract, it also utilizes an off-chain trading engine that works. While the off-chain structure manages the trading experience, the smart contract controls the funds, trade authorization, and final settlement. This allows users to trade continuously without having to wait for transactions to mine.
Security – IDEX uses smart contract, trading engine, a transaction processing arbiter to store all assets trustlessly on the platform. Here all trade settlements are authorized only by the user’s private keys. The exchange makes use of full private key encryption and allows users to trade via Ledger wallets and Metamask.
As the exchange runs on the Ethereum network, it has all the blockchain-related security measures. IDEX supports those security measures which the encrypted keys cannot access from outside of the IDEX app. When a user signs out of the app, his private key is destroyed from the app memory. The fund is kept secured using the user’s private key, and only the user has access to it.
IDEX uses the smart contracts to keep the user’s funds safely locked until the user decides to transfer them by using their private key it. IDEX has an “escape hatch” feature which allows users to withdraw directly from the smart contract after a set period of inactivity. Thus even if IDEX servers go down or are compromised users can still withdraw their funds.
Transactions Fees – The market makers – those who make liquidity by creating a new order for the order book – are charged by 0.1% fee by IDEX, while takers – those who take liquidity by filling an order already on the book – are charged 0.2% fee. The takers also have to pay the gas fee for a transaction.
Technology – One great feature of IDEX is it offers Ledger Nano S and Meta Mask Wallet integrations, which is a much safer option for fund management than manually entering your private key. Though you are still required to approve a transaction with your private key.
Though a decentralized exchange, it gives all the benefits of a hybrid decentralized exchange and manages all user transactions. After a user signs off on a transaction, the exchange broadcasts the transaction to the Ethereum blockchain, and updates account balances and order books in real time. As a result, IDEX provides a user experience similar to a more centralized exchange.
Customer Support – IDEX has a transparent support team to deal with any issues and reply users on contacting them using IDEX’s contact form. The IDEX team can also be contacted via their Telegram group and Twitter account. Additionally, there is an FAQ section to address the most common issues and a number of clearly written guides to help users to navigate the platform.
There are a couple of disadvantages with IDEX as well –
- IDEX supports only those coins that are on the Ethereum smart contract network
- The exchange does not support leveraged trading like most cryptocurrency exchanges
- It does not allow payments with credit and debit cards.
- Like other DEXs, the IDEX does not allow trading in crypto to fiat and vice versa.
Waves Dex is a decentralized exchange built on the Waves blockchain. WAVE commands a volume of 240.84 BTC which is decent for a DEX.
Coins Supported – The Waves exchange currently supports about 70 cryptocurrencies including the major ones like BTC, LTC, and ETH as well as quite a few less popular altcoins. But once the required gateways are implemented, it will be able to cover almost all the cryptocurrencies in the future. It supports fiat currencies as well – USD, EUR, and TRY tokens. The exchange allows crypto trading in ETH, BTC, WAVES, MGO as well as USD and Euro for now.
Fixed low fees:
The exchange offers a rather unique feature regarding the way it has structured its trading fees. The exchange charges a fixed fee of 0.003 WAVES on all transactions with a WAVE token costing around 7.45, just a bit more than 2 cents per trade. This is something that will be very beneficial for bigger traders later as Waves grows.
Fiat payments accepted:
Waves DEX offer deposits by Credit card and Bank Transfers, but the markups especially on credit card is very high for now. With the developers partnering with third-party providers to facilitate these payments, it is resulting in a very high fee for credit card deposits.
A Mixed implementation –
There is no counterparty risk associated with Waves DEX since all operations or transactions happens on the Wave blockchain. In order to access the exchange, users have to download the Wave Wallet. Not only the Wave Dex provides its clients full control over their digital assets on the blockchain but also accelerates the matching process by implementing a centralized matching service, thus providing the best of both worlds – the centralized and the decentralized.
A unique feature the Waves network offers is that any user can create and distribute their own version of crypto assets within its platform. Therefore, the token creation on the Waves platform will permit for the coin to trade on the Wave DEX platform. However, the WAVES platform permits for DEX to have an exchange value of 1:1 with only the genuine bitcoin assets. In addition, the tools to release your own token will have a tradable feature to leave room for token loyalty among users. Ultimately, this characteristic permits for social trading for users interested in crypto trading pairs such as BTC, ETH, Waves, LTC, etc. Waves DEX gives users with the capability to trade different cryptocurrencies in exchange for Waves or other tokens generated on the Waves platform.
Challenges for Waves to tackle –
The main issues with WAVE DEX are Liquidity and Scalability.
The trading volumes of Wave DEX is low, only 240.84 BTC, and thus increasing its liquidity level is their main objective. But its a problem all other decentralized exchanges are struggling with as well. WAVE team actively seeks out beneficial partnerships to increase exchange liquidity through their fiat gateways which is essential to build and maintain satisfactory trading volumes.
Though the use cases for WAVE DEX are fairly low at this moment, it has a great deal of potential to scale up. However, the serious use cases come as more fiat gateways are deployed thus increasing liquidity on the decentralized exchange.
Bisq or BitSquare
Bisq, formerly known as Bitsquare is a decentralized peer-to-peer marketplace for cryptocurrencies and it is a DAO. To trade here you do not have to provide your name, email ID or any verification.
Everything here is 100% transparent and open source. Bisq utilizes Tor network to be a truly anonymous peer-to-peer network and it doesn’t hold fiat or crypto coins on their servers or account either. Every aspect of this exchange from placing the order, to matching and executing it are decentralized. It is highly secure as well since there is no single point of attack and till date, no hack has been reported.
The exchange allows you to buy or sell Bitcoin for multiple currencies, both crypto, and fiat. But in order to sell or purchase fiat currency or an altcoin, you have to use Bitcoin first. Currently, including BTC Bisq exchange supports about 126 cryptocurrencies. When it comes to fiat currencies, you can choose from USD, EUR, BHD, YEN, and others.
Bitsquare exchange offers a multi-signature and security deposit system to ensure that both parties involved in a transaction act honestly and every user have control of their fund. The exchange can be accessed on Mac, Windows, and Linux platforms.
Though the exchange is a bit complex with the arbiter, the functionality is quite smooth.
The deposit and the transaction fee are rather high here. One of the major drawbacks of Bisq is the amount of capital you need to deposit to start doing trades – a deposit of .03 BTC is quite high even though the money is returned to you. The transaction fee can be as high as $20 even for a small transaction. The maker and taker fee are both 0.002 BTC. There is also a trade limit imposed to prevent hacking.
The trade volumes of Bisq is rather low – $367,618 USD or 56.76 BTC – it means that though it is a good DEX, it is still in its infancy.
The drawbacks of this exchange would definitely be the high fees and deposit and lack of liquidity. Then there are users who are not satisfied with its functionality as well. Another area the exchange is lacking is that it has not teamed up with other companies.
So the points in favor of Bisq are –
- Trading is safer and decentralized
- Possibility to make an income as an arbitrator
- Safe from thefts and hacks
- Wide selection of Crypto and FIAT Currencies
- 2-out-of-3 multi-signature security
What decentralized exchanges are trying to overcome is the issues of liquidity, scalability, and functionality, which is the main reason behind lack of mass-adoption.
To address these for Ethereum-based tokens, there are five such platforms at work – 0x Protocol, EtherDelta, Kyber Network, Radex and BlockDX by Blocknet. The popular IDEX exchange that we have discussed earlier is a unique DAO-based platform. Then there are decentralized exchanges like the Waves Platform, OasisDEX, and Binance Chain are in early development.
0x vs Kyber Network vs Etherdelta
0x and Kyber Network are two very strong platforms and considered to be leaders for future of decentralized exchanges. While 0x has their own internal token named ZRX, the Kyber Network’s token is called KNC.
The biggest difference between the two platforms is in how their order matching is done.
0x adopts a hybrid method where an intermediate party handles the order matching meaning it is done off-chain. By maintaining an order book anyone can act as an off-chain matchmaker. The smart contracts in 0x can be customized to allow market makers to set the fees for managing the transaction – accepting an order and posting it in the order books.
Kyber Network, on the other hand, addresses this issue by using smart contracts and reserves. Instead of using off-chain matchmakers like 0x, in Kyber Network smart contract are solely responsible for managing all reserve transactions. These reserves give liquidity. While a singular reserve is held by the Kyber, other reserves can be either private or public in nature.
The private reserves are those private crypto coin holders who act as a source of crypto for the exchange and are allowed to set their own rates. On the other hand, public reserves receive contributions from the public and can share the profit.
Compared to these two, Etherdelta is much weaker. Etherdelta’s ICO was launched even before the exchange was properly functioning, and then it got hacked in its initial stage and has not been able to fully recover since then.
Though the exchange is yet to do the order processing on-chain, cancellation orders are mined on-chain. The off-chain order processing does not offer any speed benefit to the user and there is complain about slow functionality as well. Since you have to wait for the next block to be mined to process further, real-time trading is out of the question.
Herer centralized EtherDelta servers handle the order book matching and because of this centralization, the contents of the order book are open to censorship. But the exchange allows you to control your own funds.
In this respect 0x is similar to EtherDelta – the 0x project has the same centralization concern of EtherDelta, but it has one major difference. 0x offers a multi-national chain which allows multiple exchanges to collaborate to build a larger order book by taking advantage of a shared liquidity pool.
IDEX vs Radex vs OasisDEX
IDEX is the only authority that may submit signed trades to Ethereum. Therefore IDEX is not a fully decentralized exchange. This provides the speed and UX of centralized exchanges, forming a hybrid model.
The IDEX platform runs on top of the free banking-inspired protocol called the Aurora DAO (Decentralized Autonomous Organization). And because of this IDEX has a multi-token structure, with three tokens IDXM, AURA, and Boreal tokens. While the AURA token (Snowglobe staking token) supports IDEX’s multi-exchange protocol, IDXM act as the DEX’s ee token for membership, and the Boreal is the stablecoin, which also enables decentralized P2P lending and free banking.
While the AURA token is given to the market makers as reward and takers pay the gas fees. To improve its liquidity, IDEX uses the Snowglobe protocol to create a secondary network of sub-chains which link various exchanges.
Compared to Radex, IDEX is a more developed and decentralized platform. But similar to IDEX, on Radex platform market makers receives a partial refund for the liquidity they provide to the exchange. Before IDEX, Radex exchange was the only one to provide this facility.
The way the platform handles its order book is not ideal. Instead of storing it in a decentralized fashion, the order book is dynamically recreated by reading the events that Radex creates. Also, in order to use the Radex exchange, you need to use its centralized Saturn Wallet plugin in your web browser.
OasisDEX is also developed MakerDAO and therefore is a competitor to IDEX. Though the exchange aims for the same level of decentralized interactions and decentralized governance like IDEX, it is only in alpha stage. The objective of Oasis is not to have the same level of token support like IDEX, but is meant for assets in the Maker registry – currently ETH, MKR, and DAI.
|Attributes||IDEX||0x and Etherdelta||Oasis|
|Concept||Off-chain trade matching with the on-chain settlement, smart contract, and arbiter||Hosting off-chain order book with the on-chain settlement. Matching is determined by miners||On-chain order book hosting. Matching is determined by miners|
|Trade speed||Real-time||Slow – limited by block time||Slow – limited by block time|
|Order Book update speed||Fast||Slow||slow|
|Time needed to cancel an order||Real-time||Slow – limited by block time||Slow – limited by block time|
|Automatic trade matching facility||Yes||No||No|
|Fills up many orders at the same time||Yes||No||No|
|The gas cost to place limit orders||No||No||Yes|
|The gas cost to cancel orders||No||Yes||Yes|
|Gas amount per trade||High||Medium||Medium|
Since all four core functions of the exchange are of decentralized nature here, BlockDX can be called as the platform with most decentralization available as of today. The exchange also has a partnership with 0x allowing interoperability with Ethereum tokens. Importantly, BlockDX comes with a decentralized API that you can connect to over localhost without permission, allowing for truly decentralized trading.
Blocknet has incorporated atomic swap feature in a technology called XChat for peer-to-peer trading without the need for a central escrow. Using XBridge, Blocknet can create an inter-chain overlay that provides a DHT-based peer-to-peer network.
The soon-to-be-released Binance Chain will provide a DEX of its own. Once it goes live, based on Binance blockchain, Binance Coin (BNB) will be swapped with a new coin at a one-to-one ratio. As per reports and educated guess, the exchange is unlikely to be a fully decentralized one. The main reason is the capital deposits will be made to Binance, and Binance, being primarily a CEX itself will not become DEX. Also, there is centralized control over the fund, as it has the feature to freeze funds to prevent hack or theft as well as to abide by the regulations.
Problems with Decentralized Exchange – An Example
A decentralized exchange in its purest form is a fully decentralized on-chain model. Let’s take the example of OasisDEX run by the Maker team which uses Ethereum blockchain.
Since it is completely on-chain, every request interacts with each other directly through the blockchain, thus making it fully decentralized, but rather slow and expensive at the same time. To execute every order, be it a cancel request or a transfer order, you need to pay gas on Ethereum as well as wait for block confirmations. This can take anything from just a couple of minutes to even several hours at times.
On top of this speed and cost issues, this DEX is also vulnerable to the front-running issue. By spending more gas you can make your order get mined first over someone else who is trying to execute against an order as their message shows up in the Ethereum mempool i.e. pending transactions.
On Tackling Front-running, Performance, and Price-time Issues – A Hybrid Approach
We have discussed the front-running, performance and the price-timing issue ingrained in decentralized exchange in general. For better user experience we should lower front-running issue, increase how fast a user can place an order and try to make it cost less. To tackle these various DEXs have adopted some form of a hybrid on-chain/off-chain model. Here traders still have to rely on a trusted third party to maintain the order book, but it poses comparatively much smaller risk than the custodial risk of transferring crypto assets into a centralized exchange’s wallet. Let’s check what different routes different DEXs are taking.
The 0x protocol team is exploring a couple of ideas to solve the front-running issue and increasing the performance. One method proposed is chaining smart contracts together on top of 0x system where the trader places a collateral amount into a smart contract without making the detail of their intent public.
Another method is called Commit-Reveal Scheme. Here a maker makes a hidden commitment to trade while depositing fund, allowing only those takers who need to follow this commitment make the settlement. If they don’t the fund is lost. Since these specific orders are hidden through encryption, and can only be revealed once the commitment is mined, it is impossible for the outside observers and relayers to front-run the taker’s intention.
However, this cannot stop multiple takers from trying to execute against the maker. Also, it cannot decrease the lack of price-time priority which is inherent in interacting with smart contracts on a distributed blockchain, thus resulting in wasted gas fees and additional delays for trading.
There is another system proposed by platforms like altcoin.io team for their plasma DEX which is another variation of relying on collateral to tackle the issue. Once you have locked up an amount as collateral in a smart contract, now you can choose where to make various action happen, i.e. either on-chain, or in a side chain, or in a centralized off-chain system. For example, a partially decentralized implementation will look like this.
The smart contract locks up a fund as collateral and but the user selects a centralized off-chain matching engine to allow for low latency trading of a variety of assets. Though settlement may happen on-chain, it does not have to be in real-time. Therefore the cost of a failure in completing can be charged to the relevant parties deposited collateral as long as the losses from the off-chain trading do not exceed the collateral amount. As per marketprotocol.io approach, you can even trade derivatives on arbitrary underlying assets.
But with some degree of centralization, the front-running and price-time priority issues can easily be solved. The 0x team has a proposal based on this idea where its “Trade Execution Coordinator” smart contract signs off on every time a match is attempted. If this process is done off-chain, may be shared by all the relayers on the network, achieving timing guarantees similar to centralized exchanges is possible. This centralization obviously means there now is the issue of potential trust, security, and regulatory issues though.
IDEX is doing something very similar. To be specific, IDEX has combined the Trade Execution Coordinator model with the collateral lock-up and off-chain or state channel approach.
Now, the question is if there is a possibility of a decentralized mechanism which will be able to take care of all three issues like prevention of front-running and price-time priority of matches? In theory, it is possible. All we need is to either shorten the block creation time on the blockchain as much as needed or adopt some kind of consensus mechanism that can take price-time priority into account.
One solution for this can be developing a protocol which reaches consensus as per the generation of time-stamped messages that are geosynchronous and then combine that with zero-knowledge proofs (ZKP) where the nodes verifying them have no knowledge of the intention of every order. The ZKP component seems to be plausible as it is similar to 0x’s Commit Reveal mechanism proposed but the Proof of Timing seems rather tough to implement.
There is another solution to the front-running problem that DEXs like alcoin.io uses. This is called the atomic swap which not only tackles the front-running issue but also allows cross-chain transactions – between two different blockchains. This technology is now more and more widely being adopted in exchanges.
This is how the atomic swap works – when two users on two different blockchains what to send each other different crypto coins, they first need to set up a smart contract on each chain. The contracts refer to each other in such a way that one can receive the fund meant for him only when he releases the fund meant for the other user. If either of them fails to hold up their side of the deal within a certain period of time, the contract expires and the crypto assets are returned to their respective owners.
Problems for Mass-adoption of DEX
There are a couple of reasons we can see that is hampering the mass adoption of DEX –
First, it is clear from the technological point of view that no government or any authorities for that matter has no control over decentralized exchanges. What this means is there is no regulation and therefore no taxation involved. If DEX is massively adopted worldwide, it will result in billions of dollars worth of crypto assets being traded globally without any supervision, control and more importantly completely untaxed. This is clearly a problem for those governing bodies and authorities as they are losing on a huge tax source.
To maintain their control, they have already passed several laws and kept imposing rules and ban on crypto trade. For example, the government of the two most populated countries India and China have taken immense measures to ban crypto trading, resulting in several CEX to close out. Then there are a few government-run cryptocurrencies like the asset-backed petro cryptocurrency of Venezuela, which is not much transparent in its operation – another way of forcing control. Not only government, but there are also some of the biggest corporations like IBM which has created permission blockchain ecosystem.
Had this been a DEX, the underlying architecture of it would stop anyone to exert any control on it – be it a governmental or private authority.
There are exchanges which claim that centralization helps in speeding up the development of the exchange – though there is some truth in it as to make a shift to DEX now they have to write the entire code which will take time. Some exchanges are saying that they are shifting more towards decentralization, but what they are becoming is a hybrid exchange.
Next, there are more than 1500 coins available in the market with more and more coming up every month and the best DEX such as IDEX only list just about 450 of them. Coordinating so many different types of coins and their technologies is truly a challenge, especially since developing DEX is very difficult and it is in the nascent stage. This results in delay and difficulty in listing all major as well as the new coins, thus posing a lot of problems for DEX mass adoption. This is also
Future of Decentralized Exchanges
So now let’s face what we can rationally expect about DEX’s future from the current market scenario of crypto space and logical possibility. We know there is a lot of reason to hope a bright future for DEXs, but as we know we have to hope for the best but plan for the worst, we would be dug out all the negative possibility DEX are likely to face.
If we are very practical about the status of DEXs, the current scenario is as follows –
- For a few 0x relayers, the volume growth has stagnated.
- The EtherDelta DEX seems to be running at much lower volumes than earlier this year.
- Other DEXs, even including IDEX and Wave are experiencing volumes that are in the low millions, and there is no clear winner at that yet.
- Though Wave did experience a sudden growth in trade volume in a short span that just made them catch up with IDEX
- When compared to CEXs’ billion dollar worth of trade it seems puny. But there is a high possibility of CEXs’ huge number to be fake, whereas in the case of DEXs it is very difficult to fake this figure.
- DEXs are primarily used to trade only those coins that are not available in CEXs. The lack of high volume trading of popular ERC-20 token type is a glaring fact
- EOS is not available in most DEXs, though it is available in EtherDelta, it is not very much liquid
What is missing here? Is it due to just a couple of algo firms stepping up for DEX service and because of offering liquidity in only major pairs? From the point of view of profit, the trading volume of DEX is too low to encourage much more effort and risk-taking. But if the required level of DEX ownership is offered to the liquidity providers so that they can make the profit in the long run, there is a genuine chance here to draw much more of their attention. They can take the risk early on and get benefitted when DEX finally takes off in full force.
The DEX bandwagon has brought forward that there is a demand for cross-chain trading in the crypto market as proven by Waves (using their own multi-coin wallet) and Shapeshift exchanges. Now, all we need is good UX. Only a few DEXs have implemented atomic swap, as the feature becomes available for all the main cryptocurrencies, the demand will be much more common.
As mentioned, DEXs are preferred for trading coins that are not available in CEXs, and if this continues to be the case for long the future of DEXs doesn’t look good. You can think about the current ICO landscape, where most are just a little more than scams, and most of the rest, though interesting and legitimate for sure, only because of the hype they managed to generate though mostly they seem worthless like ZRX. On the other hand, the most useful and valuable tokens traded today are available for discounts in exchanges.
Let’s assume that DEXs will start attracting liquidity and trade volume in near future. But as soon as they do, the scenario of currently non-existent regulations for DEXs may change rapidly. It will not be totally wrong to assume that these decentralized exchanges may have to comply with FinCEN (KYC/AML) requirements and eventually get slapped with more registrations when the U.S. regulatory environment gets clarified , perhaps even ATS and broker/dealer requirements.
We are aware that early in the article we told you that DEX provider can just publish the open source code and legally shy away from the liability for any community development based on that. This is true, well what we would like to believe as well. But there are lawyers who believe this will change and regulators and civil suits will be up for the neck of DEX providers as well as all the parties involved if there is any incident for major loss of funds. And trust us that they will be looking forward to that to happen.
Only time can tell how this will get played out for smart contracts and DApps – worst case scenario this may become a complete black market for crypto. Hardcore DEX enthusiasts are considering this for sure.
Centralized exchanges have a lot of security issues, but they are constantly working their level best to find out innovative ways to mitigate it. Therefore assume a scenario CEXs providers have managed to resolve so much of their security vulnerabilities that CEXs value proposition becomes less.
There is a more comprehensive solution for custody is in pipeline of most major exchanges. The custody issue is what is keeping some institutions and people from opting for CEXs, but this can alter the scenario. Many users in the crypto space consider the idea of managing your own private keys, a benefit of DEXs, as cost. In the ideal case, they can just give the responsibility to someone else and then just insure the key or make it safe in such a way so that risk factor becomes negligible.
Now those institutions who are not confident about crypto come aboard then they are one who will drive most of the trading volume from then on rather than the retail investors. Therefore, instead of managing their own key, it is quite natural for them to delegate or outsource the task to a trusted third party.
Now that we have covered all the possibility that may go against DEXs, we turn our attention to DEXs’ direction. It is clear that the technology behind DEX will drive a stream of inventions. The perfect DEX that is non-custodial and decentralized in nature is just an ideal case. DEX may continue to grow in popularity but reaching up to the level of their centralized peers seems unlikely at this time. What we believe will prevail is most definitely the hybrid exchanges, where it will get benefited from both worlds.
We have done our best, in the scope of the article, to first make you familiar with the different type of exchanges and then slowly moving towards addressing the issue that we set out to do. But predicting the future of decentralized exchange is difficult. The rapid pace with which the direction of crypto space keeps changing, we can only make an educated guess on the direction it is heading based on statistics and its nature.
Though we assume at the moment that hybrid exchange is future here, it may change with the invention or arrival of a new technology, method or protocol. And regardless of what invention try to set the course of crypto exchange, since it all about money, the ultimate deciding parameter will always be how much regulations and control it comes under or attracts.