Recently, we hear a lot of debate over Centralized Cryptocurrency Exchanges (CCEs) and Decentralized Cryptocurrency Exchanges (DEXs). Before jump to any debate, a simple question triggers in our mind.
“Why We Need Cryptocurrency Exchange/s?”
The answer would be when someone has Cryptocurrencies (Bitcoin) and want to sell it to obtain fiat currency (dollars) or need to have another Cryptocurrency, he or she has to look at a trusted marketplace. The trusted marketplace is Cryptocurrency exchange.
This kind of marketplaces has enough number of users and volume to exchange or trade Cryptocurrency. Thus, Cryptocurrency holders can get the best rates or exchange any Cryptocurrency with another.
Differences between Centralized and Decentralized Cryptocurrency Exchanges
At present, two kinds of Cryptocurrency exchanges are working. Centralized and decentralized.
Centralized and Trusted Cryptocurrency Exchange
Decentralized Cryptocurrency Exchange
|In centralized Cryptocurrency exchange, one must submit both keys (private and public) to the exchange (a centralized authority).
It means one has to put trust in the exchange/marketplace authority and handover the Cryptocurrency assets to known to unknown marketplace operators.
That is why it is trusted and centralized market.
|Decentralized Cryptocurrency exchange is a concept that works on decentralization of trades, payments, and accounts of Cryptocurrency holders.
Every exchange takes place on a peer-to-peer network without any interruption of any intermediary agency or system.
Decentralized Cryptocurrency Exchange
Recently, we have experienced some big accidents like hacks of 650,000 BTC from Mt Gox, 120,000 BTC from Bitfinex, and 20,000 BTC for Bitstamp.
Unfortunately, no security technology is capable of preventing frauds, theft, or loss of your Cryptocurrency assets in third-party hands (in case of centralized exchanges).
Hackers are always luring over the centralized exchange system working on the Internet and prepare as well as execute fatal attacks time-to-time.
Increased incidents and mishaps have pushed Cryptocurrency holders to look for a safe, secure, and equally viable solutions for their needs of a marketplace to carry various exchanges.
It has given birth to decentralized and trustless marketplaces or exchanges using the advanced technologies and concepts available in the market.
How Decentralized Exchange Works?
We know Cryptocurrency is based on Blockchain technology, which is nothing but a chain of distributed ledgers. Thus, it is the inherently decentralized system.
If we remove a central marketplace for exchanges and give an alternative that never holds the ‘tokens (Private & Public Keys)’ and provides a platform that allows trades in between only buyers and sellers directly, not through a central exchange system, we can overcome the majority of nuances existing in the centralized trusted exchanges.
Different Levels of Decentralization in DEXs:
Before understanding the mechanism of decentralized exchanges to know how those are functioning we must know different levels of decentralization occur in current Cryptocurrency exchanges.
- No decentralization with traditionally fully centralized exchanges such as Coinbase, Kraken, Bitfinex, and so on.
- Bancor’s project, which creates smart tokens with many coins and self-convert.
- EtherDelta a DEX with the centralized order book.
- Ox (OmiseGo) an open protocol with the centralized order book.
- Aurora a child chain application such as IDEX.
- Blocknet and Airswap using atomic swaps technology.
For the sake of the better understanding let’s take examples of two DEXs platforms, EtherDelta and Ox projects.
DEXs users must have the following essential to participate in the exchanges:
- Ethereum public key or non-Ethereum token
- Enough fund to exchange
- Enough knowledge of token exchange prices to judge the excellent trade rates
- A Blockchain enabler installed on the browser like MetaMask
Know Terminology Used in DEXs:
For EtherDelta (ED)-
- ERC20 – on-chain smart contract-based token trades.
- Centralized Order Book for off-chain trades.
- Makers – It is a user wishes to exchange coins and submit a request on order book to sell.
- Takers – It is a user wishes to buy coins and to browse for the best rates.
Functioning/Mechanism of ED DEX with Centralized Order Book:
- The Maker signs the order using Ethereum private key
- The system encrypts the order using SHA3 hash technology
- Order stores on ED server
- The Taker browses the orders available in DEX order book and selects the best one. The Taker signs the order with Ethereum private key and sends it with required funds to ED smart contract.
- Now, smart contract verifies the signature of Maker as well as assure that order is not expired or grabbed/filled by another Taker.
- After successful verification and approval nod, the system automatically transfers the reserved funds from ED server in the exchange of small fees for the entire process.
- Of course, the transaction takes place securely using unique hash and on-chain ED Blockchain technology.
Mechanism of DEX with Decentralised Orders by Relay Agents:
With the introduction of Relay Agents/Relayers, the modern DEXs are eliminating needs of any centralized order book in the case of ED DEX.
In this DEX system, Makers and Takers are not interacting directly, but relay agents are intermediate the process and ease it. Atomic Swap technology also brings a mechanism for DEX that eliminates the need of order book or relay agents at all.
In short, decentralised exchange functions based on peer-to-peer transactions with not a single point of failure. Therefore DEXs are faster and cheaper compared to centralized exchanges for Cryptocurrency. DEXs also create a globally accepted, incorruptible, and price-driven Cryptocurrency marketplaces.
Technologies for Decentralized Exchange
Many roadblocks are existing in the viability of DEXs, and some advanced technologies help to solve it at the present moment, such as
When a Cryptocurrency holder wants to exchange the stake with another holder who possesses the desired currency type, the Atomic Swaps technology/system helps them. Atomic Swaps uses HTLCs (Hash Time-locked Contacts) technology that is also known as smart contracts or NEO smart contract.
Technically, HTLC issues a deadline to accomplish the contract and payment to both parties and lock transactions outside the contract for that duration. It saves duplicate payment or creates any risk by hackers. It also needs lightening network between two parties to link payment channels together. Moreover, Blockchain of both parties uses SHA-256 grade like cryptographic hash functions to ensure secure payment by both recipients of the code generated by the system.
It is a framework to incentivize and enforce the execution of smart contracts. It is scalable to carry state updates in billions per second. Plasma reframing Blockchain computation into a set of MapReduce functions. Moreover, it has an optional method to accomplish Proof-of-Stake token bonding on top of Blockchain.
Thus, MapReduce function allows construction of fraud-proof state transitions within nested chains and block any attack by directing to root-chain block.
It composes Blockchain into tree hierarchy and frames one’s ledger entry into child Blockchain. Thus, it allows contracts in an economically viable and efficient settlement structure.
Plasma provides an autonomous incentivized system through transaction fees and enforces the continuously correct execution of data. Other technologies also are emerging in the same line to create DEXs.
Advantages and Disadvantages of Decentralised Exchanges
If you know the issues with centralized exchanges, you can easily recognize the significance of decentralized exchanges. The known issues are:
- Higher costs of operating and maintain CEX.
- Prone to security threats.
- Order arbitrage.
- Unexpected spikes in traffic that create issues with transaction scaling.
Pros of DEXs:
- The transaction is faster and cheaper
- Tough to hack means increased security
- Lower transaction and maintenance fees
- Seamless integration with wallets including hardware wallets it makes ecommerce payment easy and flexible
- Control of funds in the hands of end users means easy asset management
- Getting acceptance by being a peer-to-peer network
- No control of any government of the world, so no shutdown or interruption at all
- High level of privacy and anonymity
- Completely transparent
Cons of DEXs:
- Tough to comprehend and use
- Fragmented markets
- Missing advanced tools, features, and UIs
- Low liquidity and trading volume recorded outside the major trading pairs such as Bitcoin (BTS) and Ethereum (ETH)
- Incapable of converting Cryptocurrency into fiat currency and vice verso
- Uninsured network and without any additional services like CCEs
- The possibility of trade collisions due to block functioning
Examples of Famous Decentralized Exchanges
Let’s look at a few DEX platforms, which are popular and used by the majority of people around the globe.
- OpenLedger Dex [Bitshares]
- Bisq (aka BitSquare)
- CryptoBridge Dex
- Radar Relay
- Stellar Dex
- 0x Protocol
- Kyber Network
- Gnosis DutchX
- Bancor Protocol
Cost of Decentralised Exchange (DEX) Development
It is almost free if you are a programmer with clear basic of Ethereum Blockchain functionality or other Blockchain technologies used in the creation of DEXs. If you are an investor and seeing DEX as a business, you have two options to choose from all.
- Come in contact with an expert company in DEX development and assign your project.
- If you are a bit tech-savvy, hire Cryptocurrency exchange developer or a team of developers and manage the entire development process.
The development cost will include:
- Designing cost
- Programming cost
- Deployment cost like server setup and hosting the application
- Integration of various services, APIs, and third-party software
- Maintenance and support cost
For an accurate quote, you can exchange your DEX development idea with MXICoder, and get cost-effective quote or rates to hire Blockchain developer.
We understood the Decentralized Cryptocurrency Exchange concept thoroughly in this post. In fact, we are in a transition state from CCEs to DEXs to make digital Cryptocurrency viable in the real world for all monetary functions and needs including day-to-day expenditures/requirements.
Unfortunately, present DEXs are only available for Cryptocurrency exchanges. In the real world, we need both, Cryptocurrency and fiat currency in our Forex systems. Therefore, we need a hybrid solution with a hybrid approach to mingle the best of DEXs and CCEs both.