Traditional crypto exchanges, controlled and operated by third parties, have long had one glaring weakness: an inability to not lose user funds. From hacks to fraud, leaving funds on exchanges for extended periods of time has been a risky proposition. Even some of the longer running and largest exchanges currently operating, such as Bitfinex, Bitstamp and the now Circle-owned Poloniex, have all suffered hacks – with many, like Bitfinex, making investors absorb the costs in order to remain solvent.
In an industry built upon decentralization, it is thus no surprise that decentralized exchanges (DEXs) have grown in popularity. Although still much smaller than their centralized counterparts, currently transacting c. $1-5m per day rather than the $1bn+ of daily volumes an exchange like Binance can see, there are good reasons to use DEXs.
A primary reason is that DEXs do not control user funds. Orders between buyers and sellers are matched, with the two parties transacting between themselves via a smart contract. This reduces (although given an equally plagued history of smart contract failures, does not eliminate completely) the chances of losing funds to an exchange hack affecting user funds.
They are also often quicker to use than centralized exchanges, if only because of the time saved logging in. Because exchange accounts are such tempting targets for malicious actors, exchanges (should) mandate security features such as 2FactorAuthentication and lengthy passwords. It is also slower to deposit funds to an exchange than a DEX. Whereas users can login, deposit, trade and withdraw on a DEX in a matter of minutes, the process can be substantially longer on centralized exchanges – and varies wildly, with some exchanges seemingly manually approving all withdrawals, such is the length of delays that can be experienced.
Finally, the decentralized nature of DEXs means that there is less control over the tokens they list and on the KYC/AML procedures that prevent a user from trading. However, it should be noted that many DEXs operate in a semi-centralized fashion, delisting or refusing to list tokens. IDEX, for example, delisted a series of dividend paying assets. EtherDelta, on the other hand, allows for the trade of any ERC-20 token, as users can transact simply by using the token’s contract address. There is no need to wait for anyone to approve and list the token on the platform.
A glimpse of the future
EtherDelta was for a long spell the dominant DEX; it would frequently transact $5-10m+ per day and was the source to trade all ERC-20 tokens yet to be listed on a larger exchange. As a result, it had a strong user base attracted to the chance to grab tokens at ‘bargain’ prices before they were exposed to a larger audience. However, the exchange was hard to use and particularly struggled at busy times, constrained both by its own inner machinations and the scaling problems of the Ethereum network. Following a confused takeover of the exchange, the site has largely dropped out of popularity.
It has been replaced by a number of DEXs, with none yet achieving dominance. IDEX appeared the most likely to become EtherDelta’s successor, as it was the most willing to list any token, but it has subsequently become more guarded to new listings. Furthermore, the site is currently semi-centralized (although it plans to become fully decentralized in 2019). It is also not mobile friendly, unlike some rivals. However, it is (usually) quick to use and at crypto’s peak was seeing daily volumes of $30m+. With Ledger Nano S support in addition to MetaMask, it is also extremely easy to use. Users simply plug their Ledger in, navigate to IDEX, unlock the Ledger and can then begin trading. Each trade requires approval on the Ledger, discarding the need for any passwords or typing on the user’s computer.
In contrast to IDEX’s workmanlike approach, other DEX’s such as Airswap and Kyber are very much aimed at a more casual audience aiming for quick transfers. Both offer more attractive designs, with Airswap’s in particular clearly more targeted for ease of use than range of options. Both allow Ledger and MetaMask integration, but both are also mobile optimised; working very well through wallet browsers such as Coinbase Wallet.
DEXs aren’t confined to Ethereum, however, with the likes of Switcheo fulfilling a similar role on the NEO network. Komodo, meanwhile, allows for atomic swaps which means users can transact across Ethereum and Bitcoin based cryptoassets – for example, swapping ETH for DOGE.
DEXs remain a niche proposition at present, with few using them. However, the progress from the confusing-to-many EtherDelta to the easy to use and pleasing on the eye Airswap highlights the swift improvements being made.
However, with the exchange juggernaut Binance soon to launch its own DEX, the competition is set to intensify again. The lack of liquidity is the biggest failing of DEXs at present - if any market participant is able to quickly solve that, it will be the largest exchange in the world.
Disclosure: I have held ZRX (0x), AURA (the token for IDEX), AST (Airswap) and SWH (Switcheo) in the past, but do not currently hold any exchange based tokens.