A Decentralized Exchange is an open-source, permissionless on-chain platform for trades to take place so that there is no need to trust a third party with your private keys. The demand for such an exchange is still strong. EtherDelta and IDEX are two well-known examples. Trading is completed utilizing smart contracts on the Ethereum network instead of being done on a centralized platform. Ethereum tokens are traded on these exchanges. While Ethereum is the most prevalent, it isn’t the only platform supporting decentralized exchanges.
Although trusting a third party isn’t necessary, a lot of faith is put on the smart contract itself. Money can and has been stolen from decentralized exchanges despite the fact that many community members considered them unhackable.
There is also a concept called cross-chain atomic swapping which would allow cryptocurrencies on different blockchains to be traded in a decentralized fashion. Successful atomic swaps have occurred but there’re restrictions and a product that allows this kind of trading hasn’t fully manifested yet.
Decentralized Exchanges are the exchanges that do not require a third party to store your funds. Instead, you are always directly in control of your coins and you conduct transactions directly with whoever wants to purchase or sell your coins. This system can be achieved by creating assets (that can represent shares in a company for example) or proxy tokens (crypto assets that represent a certain fiat or cryptocurrency) or through a decentralized multi-signature escrow system, among other solutions that are currently being developed.
This system represents an alternative to the current model of centralized exchanges, where users deposit funds and get IOUs managed by the exchange. In this current model, when users ask to withdraw their funds, these are converted back into the cryptocurrency they represent and sent to their owners.
Benefits and Advantages
The most obvious benefit to using a decentralized exchange over a centralized one is that with a decentralized exchange there is no need to trust any single authority – it is a trustless service. This means that the funds are held by you in your personal wallet and not by a third party, so you are not required to trust the security or honesty of the exchange.
Another advantage to the decentralized exchanges is that they do not require you to give out your personal information. Users are not required to disclose their personal details to anyone, except if the exchange method involves bank transfers. In that case, your identity is revealed only to the person that is selling or purchasing from you.
Furthermore, the hosting of decentralized exchanges is distributed through nodes. This means that with decentralized exchanges, there is no risk of server downtime.
1. Transparent and Open
All code that is used for running the network and all transactions occurring on the network are open-source. Also, the live software is open to anyone anywhere to inspect, copy and improve upon
2. Efficient, Fast, Global, 24/7
A decentralized exchange is a global service that is available to any member of the free internet, at every corner of the globe at all times of the day. This ensures transactions and settlement within seconds. Also, there is no need for brick and mortar institutions. This means that the cost of transactions can be 10x, 100x or even 1000x less than what they are with the traditional system.
3. Incorruptibly Secure
In the traditional financial system, the intermediaries are centralized institutions that can be corrupted, robbed, hacked, or coerced. Single points of failure can be catastrophic with such centralized systems. On the other hand, with a decentralized exchange, everyone keeps control of their own keys to their own funds.
Decentralized exchanges are efficient, transparent, available 24/7, fast, global and trustless, and that’s why they are so important. As the software develops it will become more user-friendly. It will offer innovative services that are difficult to imagine at this stage. With both decentralized exchanges and Bitcoin, the “internet of money” is quickly becoming a reality that will shape our future significantly.
Downsides and Disadvantages
Some decentralized exchanges like Bitsquare require a user to be online in order for an order to be listed and for the trade to take place. This requires a user to perform certain actions like signaling that a payment was received.
Also, decentralized exchanges only allow the basic exchange of currency for a predetermined value, which means that trading features like margin trading, lending and stop loss are currently not available in the decentralized model.
Furthermore, John McAfee, the technology security expert, wrote an article recently suggesting that decentralized exchanges make it more difficult to trace funds for the purpose of taxation, which could be a problem for government regulatory agencies. Maybe this is the reason why countries like South Korea and China have recently made moves to regulate cryptocurrency exchanges.
There are several projects that have brought us the basic functions and an alternative way to trade currencies while keeping our funds safe from faulty business models, inside thefts, and hacks.
Popular Decentralized Exchanges
|Name||Platform||Volume (7 Day Avg. Est.)||Notes|
Bitshares and Openledger: Bitshares is the first decentralized cryptocurrency exchange. This platform has the best daily volume that has been around $14 million as of late, and it has its own native currency, Bitshares (BTS). Using the Bitshares platform, users can trade BTS, User Issued Assets (assets which can be issued by anyone to represent currencies, commodities, shares, and so on) and Market Pegged Assets (a crypto asset pegged to another commodity or currency which always has 100% or more of its value backed by the BitShares core currency, to which they can be converted at any time). Openledger is also on the Bitshares blockchain. This is where you can trade a decent number of different cryptos, and the daily volume on Openledger is about $3million.
EtherDelta: The objective of EtherDelta is to allow anyone to trade Ethereum-based tokens. This makes it a perfect solution for people looking to exchange cryptocurrency ICO tokens. Most exchanges either hold off on listing tokens or never do so because there just are too many from which to choose.
Bitsquare: A decentralized open-source exchange that allows users to purchase and sell Bitcoin for national currencies and cryptocurrencies in a decentralized environment which means that the exchange itself does not handle funds nor can it be hacked. Users can purchase and sell Bitcoin without the need to entrust funds to middleman or third-party, meaning that the transactions occur directly between the buyer and seller. One more thing worth noting is that Bitsquare relies on a decentralized multi-signature escrow system to ensure that all trades are carried out in an honest, lawful and transparent way.
CounterParty DEX: A decentralized financial platform and distributed open-source Internet protocol built on top of the Bitcoin blockchain and network that embeds data into regular Bitcoin transactions. It allows users to issue assets inside of the Bitcoin blockchain, and an asset that is created within the Counterparty protocol is often called a user-created token. When trading an asset for Bitcoin, the asset is held in escrow. The other user has to make a manual Bitcoin payment using the Counterparty wallet. On the other hand, when trading assets for other assets, the Counterparty protocol acts as a decentralized escrow service that holds the funds until the orders are matched.
NXT: A crypto exchange (one of the first crypto 2.0 projects), but unlike most exchanges, it is totally decentralized. This platform allows users to issue and trade assets, but these assets can only be exchanged for the coin NXT. Assets cannot be exchanged for other cryptocurrencies, and asset-to-asset exchange is also not possible.
Cryptor Trust: An investment vehicle for investing in Bitcoin and Crypto related assets, and is working on the Blockchain Asset Exchange (BAE), an open decentralized distributed platform for trading securities. Cryptor Trust is launching a new forum called Bitcoin Blockchain & FinTech with the username BlockchainForum on Telegram, and it also plans to list their own investment entities on the BAE exchange.