The Real Power of Decentralized Exchanges That Nobody Has Talked About

Decentralized exchange (or DEX) has become a popular topic and even a buzzword. The number of DEXs keeps growing. Clearly in favor of DEXs, Ethereum creator Vitalik Buterin recently claimed: “I definitely hope centralized exchanges go burn in hell as much as possible.”

To a large degree, the rise of DEXs is a consequence of one ongoing problem facing centralized exchanges —security. Because centralized exchanges (Coinbase, Gemini, Binance etc.) are custodial (meaning customers need to deposit their funds to the exchange), they are honeypots for hackers and thieves. On the other hand, one key feature of DEXs is non-custodial — customers won’t be asked to make an upfront deposit before they can trade. Also, with DEXs, trades happen on the blockchain, executed by open-sourced smart contracts, as opposed to centralized exchanges, where trades are done by their internal software.

Is DEX Too Much Hyped?

However, as DEXs continue to rise in popularity, people started questioning whether DEXs are living up to the expectations. Many disadvantages of DEXs have been pointed out, including low liquidity, slow speed, inability to fiat-to-crypto trading, lack of support for cross-chain trading, not to mention the not-so-smooth user experiences. Also, the current volume of DEX tradings is far from comparable to that of centralized exchanges.

If being trustless, more secure and more censorship resistance are the only advantages of DEXs, one could suspect: are these features strong enough to burn centralized exchanges in hell?

If being trustless, more secure and more censorship resistance are the only advantages of DEXs, one could suspect: are these features strong enough to burn centralized exchanges in hell?

Well, probably not … yet. Despite the fact that centralized exchanges are subjective to the so-called “single point of failure”, currently they are still offering better liquidity and a better user experience. Probably we will still see them being around when we wake up tomorrow morning.

A Problem With Centralized Exchanges

However, there is one thing about centralized exchanges that bothers me. When I see news headlines such as “XYZ (insert a crypto symbol here) Gets Listed on ABC (insert a big crypto exchange name here): Up by 55% in a Single Day”, I feel something strange here. Have you ever seen news releases such as “We are excited to announce our company website has been included in Google”, or seen Facebook announcing the creation of every new Facebook pages on their platform?

We are living in an era when anybody with some blockchain skills can create a fully functional cryptocurrency/token within 30 minutes, but we have to depend on a few centralized exchanges (and spend a fortune with them) to make the asset tradable?

We are living in an era when anybody with some blockchain skills can create a fully functional cryptocurrency/token within 30 minutes, but we have to depend on a few centralized exchanges (and spend a fortune with them) to make the asset tradable?

If you are sold to the idea that more and more assets will be tokenized in the near future, you can imagine a world where hundreds of thousands of tokens exist. It’s quite possible that in a few years even the small coffee shop down the street will issue its own crypto token. What about non-fungible tokens such as cryptokitties? Instead of virtual pets, in the near future we might see more “serious” uses of them. Could be CryptoVehicle, CryptoPainting. You name it.

Can you imagine in this future world, in order for the small token issued by your local coffee shop (let’s say nobody outside of your town has heard about it) to be tradable, this token has to be listed on Coinbase or Binance first? Can you imagine hundred thousands of non-fungible CryptoVehicle, CryptoRealEstate or CryptoPainting tokens fit into the dropdown menu of a centralized exchange’s website? Can you imagine a centralized exchange holding custody of a hundred thousand different types of crypto assets?

Can you imagine in a tokenized future world with millions of crypto tokens, in order to make these millions of tokens to be tradable, each of them has to get listed on Coinbase or Binance first?

Probably now you can see the problem.

TV vs. YouTube

For the time being, crypto exchanges are more or less like TV stations. When you get on it, you get excited: “Wow! I’m on TV!”. However, in my opinion, crypto exchanges in the future should function more like YouTube, with which anybody who has a smartphone and is willing to push the record and upload buttons can show their videos to the world — Everybody can do it. Nothing to be over-excited about.

Yes, getting on TV can put you in front of a large audience, just like you can enjoy a high liquidity when your token is getting listed by a centralized exchange at the current time. However, with so many videos created every minute in this world powered by mobile phones and the internet, it’d be unrealistic to rely on TV stations to let your cute cat videos to be seen by the rest of the world. That’s why we have YouTube.

When you think about it, centralized exchanges these days work just like a TV station. You can only buy or sell a limited number of currencies or tokens. For each new token or crypto to be added, some manual efforts will be needed, just like sending out a TV crew to the shooting location or inviting a guest to their TV studio.

However, if properly constructed, a decentralized exchange can work just like YouTube. The key component in a DEX system is a smart contract, which is just a piece of open-sourced computer code living on a blockchain that can let tokens changing hands when the agreed condition between two trading parties has been met. Unlike with a centralized exchange, where you have to do a different setup for each trading pairs, you don’t have to create a different smart contract for each and every token. As long as those tokens follow the same standard (for examples, ERC20 or ERC721 for Ethereum based tokens), one smart contract can take care of all possible ways of tradings — not only familiar pairs such as “ZRX-ETH”, “BNB-ETH” and “OMG-ETH”, but also “ZRX-BNB”, “ZRX-OMG” and “OMG-BNB”. Yes, you can do unlimited way of tradings with one smart contract. No additional work needed.

Centralized exchanges are just like TV Stations. Decentralized exchanges, when properly constructed, can function like YouTube.

What I just described is not theory talking or prediction. It’s already what can be done as of today. For example, you can use the 0x protocol, which is “an open, permissionless protocol allowing for ERC20 tokens to be traded on the Ethereum blockchain” (its upcoming V2 version will support ERC721 non-fungible tokens as well) to build a DEX where any ERC20 token can be traded. For a working example, take a look at LedgerDex, which was built by our team on top of the 0x protocol and recently launched. Using LedgerDex’s web app, you can freely add and trade any ERC20 tokens.

The Hidden Power of DEXs

The power of Amazon.com is not just that it will save you a trip to a local store. Its hidden power is that it can easily support almost unlimited items, including the so-called “long-tail” items, for which a physical store just doesn’t have enough space and manpower to handle.

Similarly, in a future world with potentially countless crypto assets (including many many “long-tail tokens”) that people want to trade, centralized exchanges (if they don’t change) just won’t be able to meet this need. But DEXs can do the job.

In a future world with potentially countless crypto assets (including many many “long-tail tokens”) that people want to trade, centralized exchanges (if they don’t change) just won’t be able to meet this need. But DEXs can do the job.

This is the real power of DEXs that so far has been overlooked. With the realization of this great potential, one can probably conclude that DEXs really have some strong competitive advantage over our current centralized exchanges. We can probably say it again but with more confidence: DEX is the future.

Now vs. Future

But why, with this hidden power, so far we haven’t seen DEXs gaining more popularity than centralized exchanges?

For one thing, just like YouTube wouldn’t be so popular when the internet speed is still painfully slow and there’s no smartphone shipped with a video camera yet, there are still technical barriers for DEXs (the Ethereum network is still slow and often get congested), and the token market is still relatively small (large-scale asset tokenization has not happened yet). But this will change in the future. Just look at what has happened to YouTube: now you can watch live streaming on YouTube, making it just like a TV station, and almost all traditional TV stations now have a YouTube channel.

There’s also another reason. If you take a look at today’s DEXs, with rare exceptions such as LedgerDex, you will see a similar interface just like that of centralized exchanges. Also, just like with centralized exchanges, you still can’t add any tokens you want at most DEXs (again, LedgerDex is an exception). This is not surprising. When an early internet startup decided to do something to disrupt the TV industry, it might as well just start as a showroom of curated videos. But once someone had realized an overlooked potential and decided to add an “Upload Video” button to it, a new era would begin.

But wait, what about liquidity? One huge benefit of centralized exchanges is that once your token gets listed there, you can find enough buyers and sellers. What about DEXs? Can any long-tail token find enough traders?

Let’s go back to our TV station vs. YouTube analogy. A TV station to some degree can guarantee a big audience but it has the drawback of limited airtime slots and poor scalability. On the other hand, YouTube is far more scalable and accessible but it doesn’t guarantee pageview at all. It’s up to the Youtube video creators to drive traffic to their contents. Similarly, for a future DEX where you can easily trade any tokens, the token owners might have to bring in liquidity by themselves. The creator of a long-tail token can guide their token holders to a DEX where the token can be traded. It’s just like although you can get any website indexed by Google without much effort, driving traffic to your site would be another job (and sometimes might not be an easy one at all).

Given what’s been discussed, if you believe our future is a tokenized world, it wouldn’t be too difficult to see the clear advantage of DEXs over centralized exchanges. But will DEXs eventually replace centralized exchanges?

To me, this is the same question as: will YouTube (or similar services) eventually replace TV?

Let’s wait and see.