The future of decentralized exchanges with OmiseGO

Most people heard about what happened to btc-e. The exchange got closed and potentially a very large amount of people lost a lot of money in the process. This is a good time to reopen the discussion about decentralized exchanges.

For a long time the idea was that it was not possible to run a truly decentralized exchange because eventually you need to be able to offer the ability to withdraw into fiat money. Since fiat money is centralized by definition the conclusion was that you could not have a decentralized exchange.

However something significant happened with the introduction of USD Tether (USDT), basically a token representing USD at a 1:1 ratio. It is now possible to hold USD through a token. This is similar (but the opposite) to owning an ETF:
- With an ETF you can hold bitcoin in your bank account.
- With USDT you can hold USD in your digital wallet.

The idea is that what you hold and the form in which you hold it doesn’t have to be related. You can choose what you want to hold purely on the merits of the investment itself and not because of the way it is going to be held. If you like the convenience of banks but like bitcoin as an investment you can invest in the ETF, if you like the low volatility of USD but you distrust banks you can hold USDT in your digital wallet.

As of today there is only one major issuer of USDT (Bitfinex) but that will probably change in the future and many financial institutions will decide to issue tokens backed by something else. Of course you may still need to access your USD in the traditional banking framework for example to purchase a house, but then it will probably make more sense to redeem your USDT directly with the issuer, even better if the issuer is your own bank (we can imagine a world in the not so distant future where every bank will issue some USDT tokens, you can always exchange them for USDT tokens of other banks and simply buy the one that is the easier for you to redeem).

The point I want to make in this post is that there is no real reason to merge into a single entity the exchanger and the Redeemer. The exchanger should provide security and liquidity whereas the Redeemer should provide credibility into its ability to convert the token into something else. A lot has been said about banks not liking crypto currencies, but this may very well change in the future if they are allowed to issue tokens backed by USD or other currencies. To the bank it really makes no difference if you open a bank account with them or if you give them money (directly or indirectly) in order to get tokens. They still get to have your money, invest it and loan it and just give you a receipt (no real difference between giving you a token or showing you some balance in your online bank account interface), actually issuing tokens may be much better as it doesn’t require due diligence, know your customer, customer service, etc.

Imagine a world where banks are simply about the credibility to redeem your tokens, no branches, no customer service, nothing but a conversion mechanism backed by reputation.

At this point what will really be needed is a decentralized exchange that can operate between crypto currencies. This cannot be based purely on ETH because not all tokens will be ERC20 (like for example bitcoin itself), it needs to use a complex technology based on lightning network which will allow the decentralized exchange of multiple tokens.

The company that is currently trying to build this project is OmiseGO and the project has been authored by Joseph Poon (the creator of lightning network).

Some people may ask why not just simply use bitcoin for everything? The answer is simple, governments won’t allow it. It’s not that governments will outlaw bitcoin, bitcoin will remain a very useful instrument just like gold has been. Bitcoin is basically the same as gold, an hedge for inflation, but not necessarily a good unit of exchange mostly because the price can vary compared to what is the reference unit of exchange (the government currency of a specific country).

At the moment bitcoin is also behaving as a good investment but that’s only because it is still a young technology and so the adoption is making the price rise since the supply is limited. At some point once maximum adoption will have been reached the price will probably stabilize and simply become an edge for inflation. The market capitalization has nothing to do with the ability of bitcoin to replace fiat currencies, just take the example of gold which has a much higher capitalization than all the USD available in the world (and the SP500 has even more).

What makes fiat currency so desirable for exchange is simply the fact that governments require it for the payment of taxes and use it to pay their suppliers. The government is very big, if for example the price of ETH can increase more than 25 times because people need it to buy into ICO imagine how much demand there would be for a currency that is required to pay taxes (often 50% of revenue) and that the government uses to pay all its suppliers.

Even if you only get paid in bitcoin you will still have to sell 50% of them into fiat just to pay your taxes.

I’m not saying that bitcoin cannot become the reserve currency of the world, it may very well become but when is the last time you used Special Drawing Rights (the current reserve currency of the world) to buy a coffee?

What makes a currency useful as a unit of exchange is the lack of volatility which is also the same as predictability of the value. What makes the value predictable is the government. Minimum wage is defined in the currency of your country for example. In general employment contracts will always be defined in fiat currency which will then have rental contracts defined in fiat currency too. A lot of people will say that the government is stealing with inflation, but inflation is really nothing more than a tax on savings. Why do you mind so much paying a 2 to 3% tax per year on savings and not paying a 50% tax on income? If the government were not allowed to tax savings through inflation most likely they would need to increase some other tax anyway.

Fiat currencies are not going to go away anytime soon, the way in which they are exchanged could however change significantly. What used to be banknotes could become tokens on different block chains.