When an ICO occurs and a new token enters the crypto market, crypto enthusiasts of Reddit wonder, “when polo?”
The question, short for “when [does this coin/token hit] Poloniex?”, wonders about the token’s date to hit the secondary market–i.e. the token’s initial liquidity.
Tokens are readily trade-able on platforms like Poloniex and Bittrex, which are centralized exchanges. Centralized exchanges function like traditional stock trading platforms, like eTrade, and are centralized in that the exchange holds custody of the assets and funds.
In a trade on a normal (centralized) exchange, the platform essentially issues an IOU statement which is tradeable internally on the platform, while the exchange holds everything internally in their own wallets. [The digital value is being stored in the exchange’s vault while the user must trust that when they choose to turn in their IOU for their value being stored on the exchange, that the exchange actually has the value to give them. This caveat is no small issue.]
The well-publicized downside is that these centralized exchanges are vulnerable to hacking — most notably the Mt. Gox hack in 2014, where upwards of $460 million dollars disappeared from the exchange. We are rapidly approaching a moment in history where this point of failure will no longer be an issue.
Decentralized exchanges, or DEXs present security solutions as the user controls the tokens they use in the exchange. Instead of trusting your tokens in a centralized exchange, you engage your token in a smart contract through the DEX you are trading on. Through the automated smart contract, all trades are executed Peer-to-peer (P2P), or occur between users directly with no external custody facilitating the trade.
“Trustless” in nature, decentralized exchanges do not require the user to rely on a third-party services’ security. While advanced features such as margin trading and lending are not yet available on most DEXs, their distributed hosting ensures that there is no risk of server downtime.
The implications of DEXs entering the market ecosystem will be vast and set the standard for the future of new financial applications–simply put, DEXs will revolutionize the way we engage with trading. Up to this point, decentralized digital assets have been traded on a centralized exchanges… and we have seen the vulnerability (ahem Mt. Gox). Since the trust of centralized systems has been damaged… it only makes sense to utilize a decentralized platform when dealing with a decentralized asset.
Much like how FinTech growth emerged in response to traditional banks’ lack of radical innovation, DEXs will surpass centralized exchanges as they align with the foundational principles of the blockchain, and solve critical security issues that cause people to mistrust centralized institutions. Moreover, the economic friction caused by any bottleneck or centralized institution will be alleviated by a DEX’s ability to facilitate peer-to-peer transactions. This is a fundamental shift in the dynamics of capital markets.
What are the long-term financial advantages? Why do DEXs matter?
The platforms that exist today may no longer feel adolescent to seasoned crypto-traders, yet trading is still in its early stages. A majority of all cryptocurrency transactions occur through the less-secure centralized exchanges. Withal, the market is bestrewn with smaller-scale traders who don’t fully understand the vast potential of crypto exchanges. This potential is why hedge fund managers like Mike Novogratz are not only interested in but have invested in Airswap’s P2P exchange.
As previously discussed, the increased security of a DEX removing a looming threat to everyone’s assets is groundbreaking. Furthermore, free or low fee structures that prevent front running (either from miners or the exchange itself) would ideally be present in DEXs that seek to create a more fair market environment.
A well-crafted DEX would move all the liquidity to one place (ala Olaf Carlson-Wee). This liquidity makes it particularly attractive to everyone, from the retail trader to large institutional investors and hedge fund managers. A global asset class combined with the potentially global nature of a DEX increase the likelihood of connecting a taker to a successful and agreeable trade. Additionally, the speed at which orders clear is an important factor and one that seems likely to be solved through a P2P solution.
This likely means that DEXs large and small will survive the throws of this crypto “Cambrian Explosion.” While crypto markets lack the unified framework for accredited investors to engage with more advanced markets, an expansion of application of decentralized opportunities present long term viability.
With broader adoption of not only retail but also accredited investors, DEXs have a chance to become the new “trustless” P2P institutions that holds users’ liquidity securely in one place.
“[Start-ups] initial interest is like visiting animals in the zoo. The litmus test they must now pass, is to bring the technology home to see if it will survive domestication” — William Mougayar.
Thanks are due to Zak Hap for developing these thoughts with me.