The main idea of decentralised exchanges is to be able to trade your coins and tokens on the blockchain directly without having to trust a centralised trading exchange. This should theoretically cut out the risk of the exchange losing your assets. Too many exchanges have been hacked and some have simply exit scammed and ran with their users’ funds.
So where are we now? I am going to have a look at the big promises of decentralised exchanges and the state of the art.
What Was Promised
Decentralised exchanges want to present themselves as real competitors to centralised exchanges and have many good arguments for it.
Trustless: With your funds never leaving your wallet until a trade has happened, the exchange can not effectively steal your funds.
Security: Smart contracts and order books are publicly visible which helps with audits and discovering security issues by white hat hackers. No centralised exchange offer such a level of transparency. By using decentralised exchanges you have to take care of your asset security yourself. The best way to do so is a hardware wallet.
Usability: Account creation, identity verification and further data collection is all done under the flag of “security”. In reality though no user perceives this as a feature. Centralised exchanges are trying to create a lock-in to their platform and collect data to comply to regulation.
Censorship: A centralised exchange is a company incorporated in some country and therefore subject to the laws of that country. This causes a massive pain point and enforces them to collect user data and allows them to lock your funds at any given time. Cryptocurrencies are the answer against authoritarian governments and decentralised exchanges play an important part in giving citizens of such states a way out. Centralised exchanges can not do that.
How the Real World Looks
Once upon a time there was EtherDelta which was the most used Ethereum dApp. It consisted of the smart contract handling the buy and sell orders and a graphical web interface hosted on Github pages to interact with the smart contract via MetaMask. EtherDelta was barely usable during peak times as the order book did not update anymore. The interface was anything but user friendly. But it fulfilled a very important need for the community. You could trade any token and most of the time with decent volume too.
The downfall came when Zack sold the whole project to Chinese investors. With longer downtime and an ICO announcement the community abandoned EtherDelta almost in an instant. While it is still around and is still showing some volume, a security breach in the end of 2017 shattered their users’ trust even more.
IDEX was the natural successor of EtherDelta. With some smart off-chain order matching mechanism they improved the usability tremendously without sacrificing the decentralised nature of their exchange. They are offering their own token and recently announced the staking possibilities, creating even more value for their token holders. With many tokens getting listed constantly and great volume IDEX was the go-to exchange for trading tokens and could easily compete with centralised exchanges.
The bad news is that they gave up on some important concepts that make a decentralised exchange decentralised. With their recent announcements of IP blocking and KYC collection there is no way you can call IDEX decentralised anymore. In the name of profit they gave up on one of their unique selling points.
And so history repeats itself
With just those two examples you can see one big problem of decentralised exchanges: Humans. There is always a development team behind a decentralised exchange and they can be easily corrupted. Once their exchange reaches a decent size greed kicks in and the ship is turned towards profit away from user needs.
Meanwhile the rest of the cake gets sliced too thin and smaller decentralises exchanges struggle to compete. If one eventually breaks out and gains a decent market share the cycle described above repeats itself and the exchange ends up corrupted.
The Silver Lining: Decentralised Exchange Protocols
The current landscape of decentralised exchanges looks bleak but there is one project in the crypto ecosystem that could turn it all around. Instead of building yet another decentralised exchange the 0x Project is building protocols to build exchanges on top of. The whole protocol is powered by their native ZRX token which got listed on coinbase recently. 0x Project is incorporating on-chain in combination with off-chain solutions to help others build better exchanges. It is important to note that their off-chain solutions are still decentralised. Tasks that are centralised in a traditional exchange are taken up by different actors in the 0x protocol.
This leads to a great improvement to existing decentralised exchanges – relayers can choose to collaborate with other relayers and share their order book. This increases liquidity greatly and stops the fragmentation of the decentralised exchange markets.
When the 0x Project team makes development progress the new feature is available to everyone using the protocol, giving the whole ecosystem a usability jump every time their protocol gets upgraded.
The 0x Project is naturally evolving and around it come more decentralised projects to create even bigger competition to centralised exchanges. The b0x network is following the tracks of ZRX and is creating an ecosystem of decentralised relayers for margin trading. This brings even more liquidity into the decentralised exchanges and also offers a safe and profitable way for all kinds of cryptocurrency users to make money by borrowing their coins and tokens. It would be no surprise if the b0x token (called BZX) will eventually end up on coinbase too.