Decentralized Exchanges! Like everything else in the crypto space its an interesting idea beaming with hope, but kind of difficult to fully understand. Today I will discuss what decentralized exchanges are and their true potential. I will not be reviewing specific exchanges or providing any trading tips. Ok, lets go!
A decentralized exchange, aka DEX, is a market structure made up of a network of devices that allows investors to create a marketplace without a central or ‘third party’ service. Instead, trades of funds take place peer to peer and in a distributed manner.
Decentralized? Distributed?… Wait! I know, more buzzwords. Let’s break down some general terms in the context of this post before you find a cat video and I lose you.
- Centralized — concentration of control in a single point
- Decentralized — dispersing control from one central point to many smaller central points
- Distributed — dispersing control from many central points to individual non-centralized points
- P2P — peer to peer, usually referring to a network of individuals interacting directly with one another without a centralized entity
- Liquidity — availability to buy and sell an asset without affecting its price. Think of an asset pool which needs to hold enough assets in that pool to cover demand from buyers and sellers without running out and creating problems
What is the purpose of a DEX?
DEXs main focus is to decentralize power, control, and risk. It is easy to incorrectly label an exchange as ‘decentralized’ when they claim to have one decentralized feature about them, although you would not be far off. DEXs can be best described as belonging to a proportional system of measurement, which means they lie on a spectrum. It can range from fully decentralized and distributed to decentralized, but, with some centralized points — so many gray areas! Here’s a handy diagram to aid our understanding:
The potential of DEXs
First, DEXs provide a new take on liquidity. If all DEX users and asset order books can be shared and connected, you can have trades between disparate pools of money. This could give the network infinite liquidity. Second, increased security and reduced risk. We get more security because all assets are spread out to the edges versus in central points, so no single point can be targeted as a honeypot. You could still hack one point, but would only get that point’s assets and nothing else. Lastly, you get more privacy. Everyone contributes and members can interact in a P2P manner versus interacting with one entity that has access to all assets. Your information could still be exposed, but only with the one point you are exchanging with.
The community and the DEX spectrum
Since DEXs lie on a spectrum, is there really a truly ‘decentralized’ exchange? Well, no, not really. Bitcoin and cryptocurrencies are all part of a giant on-going experiment, so all combinations are being explored in order to find that one unicorn. Some exchanges will sacrifice full decentralization by using, let’s say, a central server to facilitate P2P trading but this allows them to scale faster. Others will sacrifice user experience in order to provide higher levels of anonymity and distribution, which could slow things down. Challenges abound!
Knowing this, as long as we have multiple teams working towards finding what works best, I believe we will find an answer. Our focus shouldn’t be on who does what better than the other or how they are best or the worst at x or y. In the end it’s more important to remain open, collaborate, and learn from one another in order to reach our common goal: moving away from centralized power.
Thanks for reading! This is my first crack at DEXs and I will follow up with more blog posts to discuss current DEXs in the market, how they work, new developments and what direction they are headed.
