How does no-fee, anonymous trading sound to you? Too good to be true?
Well, it’s already here.
“Decentralized” exchanges (DEX) like the Kyber Network, Forkdelta and IDEX allow you to trade Ethereum tokens and other digital coins directly with other counter-parties (users).
These exchanges are not brokerage houses, but peer-to-peer trading networks.
Do you remember Napster of the early 2000s? How about the Pirate Bay & the torrent network (currently on its third iteration)? That’s the idea behind these exchanges: Decentralization
What these networks all have in common is there is no central authority. No central server that can be hacked or shut down by government authorities. Anti-money laundering (AML) and Know-your-customer (KYC) legislation doesn’t apply with these networks.
This new wave of cryptocurrency trading allows transactions to be completed directly from your wallet, and your wallet can be completely anonymous.
And if you are trading directly from your wallet, the chances of your funds getting hacked or stolen go down drastically.
These decentralized exchanges have just started hitting the street. They are difficult to use, even for techies and they don’t have a lot of trading volume…yet. But they are becoming more popular every month.
How Do They Work?
You need to understand a little bit about Ethereum before you understand how DEXs work.
In Ethereum, tokens (called Ether) can be transferred between addresses. An Ethereum addresses is an alphanumeric number that is 42 characters long, for example: 0xc659bA480EF6b88910BAA887b6e65BC50D47D90CB.
Every Ethereum wallet has at least unique 42-character address. To put Ether tokens in your “wallet” you send Ether to that address.
However – and here is where it gets interesting, while all Ethereum wallets must have an Ethernet address, not all Ethereum address are wallets: some are smart contracts.
While Ethereum wallets are owned by somebody, whether it be a individual investor or a corporations, Ethereum smart contracts are owned by nobody; they are part of the Ethereum network.
Are you confused yet? Here is a textbook definition of an Ethereum smart contract:
Smart contracts are self-executing contracts with the terms of the agreement between buyer and seller being directly written into lines of code. The code and the agreements contained therein exist across a distributed, decentralized blockchain network.
To simplify even further, smart contracts are bits of code embedded in the blockchain network. The smart contract is triggered when Ethereum is sent to the address of the smart contract.
A collection of smart contracts working together is called a distributed application (DAPP). The decentralized exchanges like Forkdelta, Khyber and IDEX is nothing more than a DAPP running in the Ethereum network.
You Can Shut Down a Crypto-Exchange, But How Do You Shut Down a Network?
At present, crypto-exchanges, as businesses, have to be located somewhere. Like in a specific country.
The crypto-exchanges that were based in China had a bad time late 2017 as the Chinese authorities decided to outright ban cryptocurrency.
Even in crypto-friendly countries, like Japan, crypto-exchanges can get shut down if the authorities believe they are compliant with the legislation of that country. Two exchanges in Japan were shut down just last month.
But these decentralized exchanges don’t reside in any one country, they live in the Ethereum network. And Ethereum is everywhere.
Sure, you can go after the development teams of these DEXs and somehow try to persuade them to shut down what they started. That is, If you can find what country the developers live in and somehow get them extradited (good luck with that if you’re Chinese).
These exchanges can run without any human intervention.
Take the example of Etherdelta. It was one of the first decentralized Ethereum exchanges to be activated. But the development team got bored of maintaining the code base and disappeared.
That is to say, nobody is actively managing Etherdelta. It’s buggy, slow, and users are abandoning it for exchanges. But it still runs by itself.
Decentralized exchanges are not unique to Ethereum network either.
Openledger.io is another decentralized exchange but it’s not based on the Ethereum network. It’s based on the Bitshares platform, an entirely different code base from Ethereum.
The “idea” of a decentralized exchange has caught on like wildfire among the blockchain development community. Nobody will be able to put the genie back into the bottle.
At present no regulators are panicking. These new decentralized exchanges are very difficult for the average investor to use and trading volume is still very thin.
IDEX has the most trading volume of all the DEX and it trades only $2 million USD a day. Etherdelta trades under $1 million. That is a drop in the ocean compared to Bitfinex ($770 million a day) and GDAX (315 million).
I have tried using many of these exchanges. They are incredibly, clunky, and slow. Etherdelta got hacked at least twice before the development team walked away.
But no fees! Centralized exchanges charge anywhere from 1% to 0.25% per trade. That can add up if you want to do crypto-arbitrage, a very lucrative form of trading during times of market mania.
Also, let’s not forget the great freeze of December of 2017, when onerous KYC and AML rules, combined with an influx of new customers, virtually brought the crypto-exchanges to their knees.
A large segment of the established financial order sees the rise of unregulated crypto-exchanges as a threat, and have burdened them with legislation and outright bans.
But what happens when a critical mass become decentralized and can run by themselves?
Of course, it may take years instead of months to find out as the DEXs go through their growing pains.
While a big step forward has been taken with the successful launch of many of these exchanges, they still have to improve the user experience, quash the bugs, and scale up the throughput.
The change will seem gradual, even glacial. Until one day people wake up and DEXs rule the trading world.