How Decentralized are DEXs? A Classification System for Decentralized Exchanges.
Decentralization is a popular term used to market products and services in the cryptocurrency space. However, an exact definition for what classifies a product or service as decentralized is still hotly debated. There are numerous financial tools, exchanges, and blockchains that tout being decentralized but have a considerable amount of centralization in their infrastructure.
Binance DEX, for example, has recently undergone scrutiny for blocking America and 28 other countries from accessing their service — an action indicative of centralization — despite their claim to decentralization.
Is Binance DEX Decentralized?
To answer the question of whether Binance DEX can be considered decentralized or not, we’ve created a framework to classify how decentralized a given exchange is.
We picked some of the most popular exchanges used in the cryptocurrency space and analyzed their operations. Our criteria for a service to be included in this analysis involved it needing to facilitate the exchange of one cryptocurrency for another and be marketed as an exchange.
The factors we considered when evaluating a given exchange’s degree of decentralization includes:
- KYC requirements
- Control of transactions
- Order matching
These exchanges take custody of users’ funds, require users to provide information about their identity, have the ability to censor access, manage order matching, liquidity, and settlement using internal resources, and are built using centralized infrastructure.
These exchanges never take custody of users’ funds and have on-chain settlement. They do, however, require users to provide information about their identity.
A permissioned exchange does not take custody of users funds, does not require users to provide information about their identity, but does have the ability to reverse transactions and censor who has access to their services.
A permissionless exchange does not take custody of users’ funds, does not require users to provide information about their identity, cannot reverse transactions, but has limitations on which tokens can be traded and/or which users can access their services.
These exchanges do not take custody of users’ funds, do not require users to provide information about their identity, cannot reverse transactions, and have not censored access to their services. Order matching and liquidity pools are managed off-chain.
These exchanges are what crypto developers consider true DEXs. They are non-custodial, permissionless, do not censor access, and settlement, order matching, and liquidity are managed on-chain.
In a fully decentralized DEX, development and infrastructure are decentralized too. MetaMask using Infura and development teams depending on a few key developers are factors that prevent any DEX from being considered fully decentralized.
*ShapeShift is Custodial
Although ShapeShift markets itself as non-custodial, there is a point where users funds are in their possession. During a swap, ShapeShift accepts users’ tokens as payment and then compensates the user with tokens from their internal reserve. This means users need to trust that ShapeShift will compensate them with funds after the funds are in ShapeShift’s possession.
ShapeShift is being truthful about being non-custodial: they do not require you place funds into a hot wallet in order to trade with them as most CEXs do. However, the transaction process could be less centralized.
**Binance DEX is a Permissioned DEX
Within our classification system, Binance DEX displays a level of decentralization equal to a permissioned DEX.
Since Binance DEX does not have full node open-source code, Binance maintains full control of its blockchain and has made it impossible to verify whether Binance DEX has back doors or not. Until there is an increase in transparency, we cannot consider Binance DEX decentralized.
Although ideally a DEX would be transparent and accessible to everyone, companies pioneering the blockchain space will need to avoid legal hurdles that could threaten their stability. Using centralized technology is a reliable way to stay flexible in order to overcome unpredictable legal hurdles.
Totle’s DEX Evaluation Process
For Totle to consider adding a DEX into our network, they need to have atomicity. This means we need the ability to swap tokens atomically (the exchange of tokens without the involvement of a centralized intermediary) in a completely permissionless manner.
Therefore, only exchanges with the classification of permissionless or higher are included in our services.
Building with DEXs is Easy
Totle manages decentralized liquidity so that developers can stay laser-focused on building powerful, decentralized products that can beat out centralized solutions.
We’ve aggregated the top DEXs in the cryptocurrency space and built an API that automatically routes orders to the best prices available. Totle is non-custodial, peer-to-peer, transparent, and does not require KYC.
To start using Totle, access the API here: Build with Totle
If you have any questions, you can email Totle at firstname.lastname@example.org
Thank you to Kyle J Kistner for inspiring this article. We recommend checking out How Decentralized is DeFi? A Framework for Classifying Lending Protocol