Coingape posted an interesting article yesterday talking about what the future of cryptocurrency might look like in 2019, now that 2018 is drawing to an end. The article listed four indicators as to what the next year might look like and if you’d like to check the article out for yourself, you can find it at https://coingape.com/the-future-of-cryptocurrency-2018-draws-end/. The point I was most interested in was that exchanges are changing and decentralized exchanges could become a lot more popular, but what does a decentralized exchange look like?
What is a cryptocurrency exchange?
A decentralized exchange works differently than your average exchange as your average exchange is still mostly centralized. The fundamentals of an exchange, according to blockgeeks (https://blockgeeks.com/guides/decentralized-exchanges/) are capital deposits, order books, order matching, and asset exchange. The only thing that is decentralized in your average centralized exchange tends to be the asset exchange (as cryptocurrency is decentralized). However, when you join an exchange you still have to give them a proof of identity, which they then store in their databanks. A centralized exchange will also use their server to match your sell, or buy, order with someone who is looking for that kind of transaction. However, by having all this information, and your assets, stored on centralized exchanges was how it was possible to have those massive exchange hacks that have taken place over the last couple years.
Decentralized exchanges
A decentralized exchange works quite differently as they are either trying to become entirely decentralized or become what is known as a ‘hybrid.’ Instead of having a centralized server for funds, all transactions would be peer to peer. As there is no centralized server and everything is peer to peer, they do not need proof of identification. A lot of decentralized exchanges identify you by email signup or by your smart wallet. If someone wants to make a transaction with another person, then everything is taken care of with Smart Contract. The problem with decentralized exchanges is figuring out how to set up order forms and matching people together; this is where some exchanges split and become ‘hybrids’ or take the hard route and try to become entirely decentralized.
Why do I say decentralizing your order form is hard?
When you are trying to buy or sell an asset on a crypto exchange, you send the order, and the exchange links you to another person that their order matches yours. If you want to sell three bitcoin, they will match you with someone who wants to buy three bitcoin. However, when you take out that centralized server that is doing the work, it becomes hard to fill that void.
Decentralized exchanges have gone about it different ways, one way is people manually matching people together, and these matchmakers are called "relayers" that make a finders fee, of sorts, out of the transaction.
However, there are problems with this as it has vulnerabilities and ways people can abuse this system. For example, if a relayer matches a buyer to the seller, the seller can cancel the sale, go offline and message that person to make the deal outside of the system as they know that person already wants to buy, and then the relayer isn't making any money for their work. There have been other approaches to this system, and the reserve system seems to be gaining some ground. The reserve system works by having certain individuals sign up to become reserves, and they will hold a certain amount of assets. Other people will agree to support this idea and loan them assets and then if someone wants to buy some assets, it will come out of that reserve. This idea seems to work similarly to how the average centralized exchange works, however, the weight is spread out and so there is no single point of failure.
Decentralized exchanges are an exciting concept, and the attention that they're getting is warranted. However, there are still some kinks to work out, as there isn't a centralized server approving and smoothing things out, efficiency on the broad scale is a concern. As decentralized exchanges are still relatively new, it will take time to build up the business to see if they can handle the load. But, if any of you have had some dealings with decentralized exchanges, please leave a message and tell me your experience.
-Written by James Hepburn