Is Your Favourite DEX Useful (Or Decentralized)?
Let’s take a look at the DEX claims
Decentralized exchanges (DEX) are the next big thing in the crypto world. The likes of Vitalik Buterin has said of centralized exchanges:
I definitely personally hope centralized exchanges burn in hell as much as possible.
Pundits and crypto enthusiasts see centralized exchanges as the antithesis of the true nature of Satoshi Nakamoto’s vision, where big central clearing houses are needed to do something as simple as trading funds. These central exchanges are prone to hacks, control vast sums of crypto and cash in place of the owners and have access to wide ranges of customer data. The rise of several decentralized exchange projects is easy to forecast in this climate. Many new exchanges are marketing themselves as decentralized with many taking centre stage such as Bancor, 0x and IDEX.
But are these exchanges actually decentralized? Or do they just provide less centralized features?
How Exchanges Work
Crypto exchanges provide specific functions for customers. These include order books, order matching, exchange of assets and the ability to deposit capital. For an exchange to be decentralized, all of these services must be decentralized.
Decentralized exchanges let users trade peer-to-peer basis without using a platform operated by a single entity. This means the networks nodes would need to be distributed.
In central exchanges, cryptocurrency asset exchange is necessarily decentralized because cryptocurrency exists on a blockchain. But record collection for Anti- Money Laundering functions means the depositing of funds is done in a centralized way to identify and collect needed information. Additionally, the exchange matches orders through internal mechanisms on a central server.
For an exchange to be decentralized, the order book, order matching and deposit functions will all have to be executed by groups of nodes.
How Current DEXs Stack Up
Recently, analytics firm Alethio did research on the centralization level of different decentralized exchange models. They found the decentralized exchange models on offer have varying degrees of centralization.
Some attempt to decentralize a traditional exchange company, such as the Huobi Chain Project announced in June, while others seek to build a community with stakeholders around a peer-to-peer model, like 0x.
“Decentralized exchanges are making headway toward the re-elimination of central parties in that [crypto trading] system,” said Wall Street veteran Jill Carlson.
DEX use market makers. Market makers provide liquidity in the market by buying and selling at all times, allow orders to be fulfilled for end users. Central exchanges themselves act as market makers on their exchanges, making the trade process simple and generally quick for end users. This is a centralized model. Bancor, though it was marketed as a decentralized exchange, was the only market maker for their exchange when it was hacked earlier in the year. Because they were centralized, they had the ability to both freeze trading on the platform and freeze customer funds.
DEXs usually crowdsource market makers, and provide them the incentive of either trade fees or additional tokens to provide their service. The problem some have faced is the lack of diversity in their liquidity pools (ie. makers).
Other projects, like 0x which seems to have many market makers, actually rely on independent relayers for token trading. Trades are done through relayers- companies that run sometimes proprietary software on top of an 0x layer and are responsible for regulation requirements. There are as few as 17 relayers in the 0x network, one of which is owned by one of the world’s largest centralized exchanges, Coinbase (Paradex). With this situation, we run into the issue of very few parties being able to collect vast amounts of data and control in an exchange.
Additionally, past these concerns, decentralized exchanges still have issues with trading between cryptocurrencies, with most only doing token to token trades. Not to mention, fiat to crypto onboarding still is an issue that limits liquidity, volume and the ability for serious traders to get on board.
Because of these concerns, the proponents decentralized exchanges are still looking for the major project that makes the community’s hopes a reality.
