Over the past three years, centralized cryptocurrency exchanges have been in full bloom, with most of these structures developed and deployed in a relatively short period of time.. Given the high complexity of the assets they deal with (crypto tokens versus securities), as well as short testing periods and lack of history, it is not surprising that most of these exchanges are vulnerable to attacks.. In fact, most of the leading cryptocurrency exchanges in the same three years fell victim to such attacks, which almost always led to huge losses: Bithumb, MtGox, ShapeShift, Bitfinex, Yapizon, Cryptsy – the list goes on if you wish.
In addition to being vulnerable, the centralization principle underlying such exchanges goes against the very spirit of decentralized blockchain.. These reasons led to the fact that the attention of investors and developers turned to decentralized exchanges or DEX (DEcentralized eXchange). The three-year period brought a lot of such projects – most of them have not yet left the development stage, but several working platforms have already managed to gain a reputation.
The vast majority of decentralized exchanges are concentrated in the Ethereum ecosystem – they will be discussed below (ether and ERC20 tokens). As for the support of other cryptocurrencies, here the main hopes are placed on atomic swaps, although so far these are only experimental developments.
Currently, EtherDelta, OasisDEX and the 0x protocol launched in August, on which other exchanges will be built, are already working.. Bancor is in development, while the AirSwap and OmegaOne projects are just preparing to hold an ICO.
Interestingly, up to 40,000 transactions per day are now going through EtherDelta, which is about 14% of all daily transactions on the Ethereum blockchain.. We can say that this is the most requested Ethereum application at the moment.
Pros and cons of centralized exchanges
A cryptocurrency exchange should perform three main functions:
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Liquidity – quickly find a partner to make an exchange;
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Efficient valuation, leaving as few opportunities for arbitrage as possible;
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Fast settlements.
A centralized exchange is able to ensure efficiency both in finding a partner and in mutual settlements – the order book and mutual settlements are located on the exchange servers, and the corresponding operations can be done much faster than on the blockchain. The effectiveness of valuation is mainly determined by exchange volumes.
The flip side of these advantages are security issues (centralization) and the presence of a vulnerable intermediary (the threat of both fraud and any action by the state).
How can a decentralized exchange solve these problems?
Security – DEX users control their funds on their own, until the very moment of mutual settlement in the blockchain (although the speed of this operation is much slower). Other problems are somewhat more complex, and DEX projects offer various ways to solve them.
Liquidity or Finding a Partner Quickly: Searching for a counter order can be done using the order book (some degree of centralization, and delays between placing an order and settlement can lead to stuck orders); having own reserves (maintaining one's own balance), or using a direct P2P transaction (difficulties in finding a partner).
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Order book: can be off-chain or on-chain. Off-chain order book (EtherDelta, 0x) is easier, if you do not take into account the risks of increased centralization. Exchanges solve this problem by refusing to automatically select counter orders (rejecting the intermediary) – the party responding to the order must sign a specific counter order, which only after that is sent to the smart contract. This scheme has a negative impact on liquidity. Here 0x goes a little further – Relayers, which can be anyone, can create multiple order books, versus EtherDelta's centralized book.
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On the other hand, the blockchain order book (OasisDEX), although ideal for DAapp, still many users are not enthusiastic about having to pay gas fees for any operation – order cancellation, price change, deposit / withdrawal of funds, etc.. d.
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Reserves: Orders can be executed quickly if the exchange has its own reserves (Kyber, Bancor Protocol), however this scheme requires maintaining its own balance. Kyber offers a solution where a third party can create a reserve with a pool of tokens backed by other participants or centralized exchanges.
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P2P: Direct price agreement between participants (AirSwap, 0x) via private messages – however, this is a long process. In addition, matching a counter order requires a third party (centralization) and determining the agreed price can be time consuming.
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Reference Price: Most decentralized exchanges have to rely on order books/reserve prices to determine their reference price when making trades.. However, as long as the volume of trading and the number of participants are insufficient, price determination may not be optimal, and the exchange will have to rely on external sources or centralized exchanges.. In turn, P2P exchanges will always depend on a third party to determine the reference price.
The table shows the comparative characteristics of decentralized exchanges:
Who will win?
The smart contracts described above are much more secure than centralized exchanges, but security is not likely to be the deciding factor.. Users will prefer speed, no market manipulation, and low transaction costs.
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Speed: Exchanges with blockchain orders (OasisDEX) and P2P (AirSwap) will remain slow, their speed will not increase with volume growth. The speed of off-chain order book exchanges (EtherDelta, 0x), although slow, will increase with volumes.
Note: The situation may change after the Ethereum scaling challenges are resolved.
Exchanges that have their own reserves (Kyber and possibly Bancor) can be almost instantaneous, but only on the assumption that Kyber and peers manage to create and maintain adequate liquid reserves. -
No intermediaries: OasisDEX does not have an intermediary. Exchanges with centralized off-chain order books (EtherDelta, 0x) are subject to DoS attacks from order book managers; orders stuck in the book are targets for arbitrage trades. In AirSwap, there is a need to trust the service that helps to find counter orders (Indexer) and the oracle API that provides the cost. At Kyber, the network operator decides which providers of reserves are allowed and which are not.. Determination of the price of the token by the provider is also a problem: an error can lead to a rapid depletion of the reserve. It was the pricing methodology that became the object of harsh criticism of the Bancor protocol by Emin Gun Sirer.
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Cost: blockchain settlements require gas fees. As for other costs, the winner will be determined only as a result of competition: Relayers in exchanges built on the basis of 0x, as well as liquidity providers in Kyber, intend to charge users fees, which will vary.
Conclusion
Many decentralized exchanges are expected to appear in the very near future. About a dozen teams have already announced the creation of exchanges based on the 0x protocol. The first such project to reach the open beta stage was RadarRelay, and the operator OasisDEX MakerDAO has already announced a partnership with 0x in further development. AirSwap ICO will take place on October 10, but for now, EtherDelta remains the undisputed leader, by the way, developed without any third-party funding.