Are Decentralized Exchanges Critical for the Future of Digital Assets?

The revolution blockchain promises to bring goes primarily in returning the privacy and sovereignty back to people and cutting out the middleman. A middleman that took advantage of people for ages. Blockchain and its applications such as digital assets (i.e. cryptocurrencies, and tokens) are decentralized, meaning no central authority can manipulate or dictate its rules, or sign and approve a transaction, which is similar to how banks operate. The decentralization of this technology is the main reason it’s a prime candidate for being one of the pillars of the fourth industrial revolution. Because of how Blockchain is constructed, it is near impossible to hack. In addition, Blockchain allows for granting ownership back to users by facilitating peer to peer transactions, which is especially useful for cryptocurrencies. Digital assets exchanges introduce different vulnerabilities making digital assets the new wild west. Hacks from millions of dollars to 100’s of millions of dollars across the globe are possible. The exchange of digital assets is mostly conducted on centralized exchanges, this is a recipe for disaster to exchange decentralized tokens, essentially paralyzing the mainstream adoption of this new class of assets.

If a bank is hacked and consumer(s) assets are robbed, usually the bank pays back the stolen assets to its rightful owner(s), as those assets are technically owned by that bank and both are essentially centralized. However, if decentralized assets get hacked by breaching a centralized server, those assets are more difficult to trace and recover. Centralized exchanges work by storing the private keys to those assets in their servers, that essentially means they own those keys. Therefore, this raises the risk of insider threats in addition to outsider hacks and breaches. Trusting our digital assets in centralized exchanges defies the main purpose of this technology and why it was even developed. Blockchain was built to transform the trust of a centralized authority to the trust of no authority by leveraging computation using decentralized distributed nodes. Essentially that means no one is required to be trusted. Therefore, no single authority is needed.

The development and enhancement of Decentralized Exchanges (DEXes) are essential for the survival of digital assets. Centralized exchanges are the dominant means to exchange decentralized digital assets and, due to the repeated hacks and security breaches, this introduced a lack of trust into the ecosystem. Practical DEXes with the same or better functionality than centralized exchanges may bring in larger trade volumes, and as hacks start to diminish given that decentralized exchanges does not store critical information on centralized servers. This in turns will facilitate the adoption of this new class of assets. DEXes are also a crucial component for an increased degree of fungibility in cryptocurrencies, if you’d like to read more, refer to this article “On Fungibility, Liquidity, and the Importance of Decentralized Exchanges

Even though DEXes are fundamental for cryptocurrencies to survive and eventually thrive they also suffer from multiple problems, such as, their interface not being user-friendly enough, the transaction speed is slow due to validation delays on the blockchain(s). In addition, there is a potential high cost per trade. Take OasisDEX, one of the purest forms of the currently available DEXes. It’s a fully decentralized on-chain model. The exchange orders interact with each other directly through the blockchain. However, it’s expensive and slow, from order cancellation to transferring cryptocurrencies. All of which requires paying gas and waiting for hours sometimes to get block confirmations. On the other hand, another DEX called IDEX  validates transactions using its own smart contracts before submitting them to the Ethereum network. Essentially this allows IDEX to validate every trade before being executed. Also, it can update account balances off-chain after a transaction; therefore, using a feature of a centralized exchange without breaching security.

Multiple platforms claimed they’ve built DEXes; however, until now none has proved how decentralized they are. The main problem is that DEXes still embeds centralized features, and if not they introduce multiple problems such as high gas cost of each trade and slow transaction speed. This may be due to the development of DEXes still in its infancy. The development of DEXes may not introduce fully autonomous features at least for the foreseeable future. However, it’s critical for the DEXes to keep transactions purely peer to peer and stay away from storing the ownership keys (private keys) of digital assets in a centralized fashion. And if at all possible they should also reduce the transaction speed and gas cost of each trade.

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