For years, increasing decentralization has been one of the main objectives of the blockchain industry. While this is a worthy, albeit rather abstract, goal, the word “decentralization” now seems more like a marketing buzzword than it does a design principle or guiding ideology.
This is most evident when it comes to digital asset exchanges. Recognizing the challenges of centralization, like custodial trading and massive security vulnerabilities, many exchanges, both old and new, have taken to calling themselves decentralized exchanges (DEX) without ever explaining the properties of a true DEX or how they rise up to meet the standard.
While many of these so-called DEXs are, indeed, less centralized than traditional custodial exchanges, they still bear the mark of centralization. Just because an exchange is slightly less centralized than a fully centralized exchange doesn’t mean we should call it a DEX.
In this blog post, we will establish the core requirements that must be satisfied in order for an exchange to qualify as a DEX. Then we’ll explain how AtomicDEX, Komodo’s third-generation atomic swap powered DEX, is the only exchange in the industry that satisfies all conditions.
The debate over the word “decentralized,” and what exactly it means, is not a new one. In this excellent essay by Tony Sheng from September 2018, a few different definitions of “decentralized” are put forth:
- “‘Decentralized’ is defined as the opposite of ‘centralized.’ ‘Decentralized’ is an ‘antonymic definition’— defined only as the opposite of something else.”
- “Cambridge Centre for Alternative Finance describes decentralization as a property that emerges from the roles, behaviors, and influence of actors on each layer–protocol, network, and data of a distributed ledger.”
- “Vitalik takes a crack in early 2017: ‘Blockchains are politically decentralized (no one controls them) and architecturally decentralized (no infrastructural central point of failure) but they are logically centralized (there is one commonly agreed state and the system behaves like a single computer)’.”
- “As Sarah Jamie Lewis says in her thread on decentralization… decentralization is the degree to which an entity within the system can resist coercion and still function as part of the system.”
Ultimately, Sheng suggests that defining “decentralized” and measuring decentralization is neither possible nor particularly relevant because:
“‘Decentralized’ is a platonic ideal that trust and power are distributed in a superlatively fair way. It’s not something that can be reached, but a useful thing to reach towards.”
While Sheng is right that nailing down a precise and universally accepted definition of “decentralized” is not a realistic goal, it is useful nonetheless to put forth some basic criteria— conditions that are necessary but perhaps not always sufficient— in order for a project, app, software, or system to be considered “decentralized.”
Specifically, we should try to define the requirements that must be met for an exchange to be considered a DEX.
The 4 Core Requirements Of A True DEX
There are at least 4 core requirements that an exchange must meet before we should consider it “decentralized.” This is not an exhaustive list and these core requirements will surely evolve over time as blockchain technology continues to evolve, too. But it’s still useful to have criteria in place to help us evaluate the degree of decentralization of DEX projects.
1. A DEX must be non-custodial.
Traditional crypto exchanges are custodial, meaning that they take custody of users’ funds before those users can make trades. On one level, this makes sense, as it ensures that users are not making trades with assets they don’t actually have.
In many other ways, this system makes very little sense. It completely undermines the ethos of decentralization on which the blockchain industry was founded. Centralized digital asset exchanges are replacing big banks and becoming the powerful middlemen of the blockchain industry.
The centralization of digital asset trading has also introduced major security vulnerabilities, which hackers have gladly taken advantage of. In 2018, hackers stole an incredible amount of wealth: estimates range from $877 Million to $950 Million all the way up to a cool $1 Billion.
To date, the trend has held strong in 2019. Malicious hackers continue to rob both exchanges and everyday holders of digital assets blind. An estimated $227 Million has been stolen from centralized exchanges thus far in 2019.
In particular, hackers stole $16 Million from Crytopia, eventually leading to the exchange’s demise; $19 Million from Bithumb, making it the third time Bithumb has been hacked in 2 years; somewhere between $45 Million and as much as $105 Million from Coinbene, although Coinbene never publicly acknowledged the security breach; $40 Million from Binance, the world’s largest digital asset exchange; $4 Million from Bitrue, a Singaporean exchange; $10 Million from GateHub, a Slovenian exchange; and $32 Million from Bitpoint, a Japanese exchange.
In other words, centralized exchanges are the perfect target for malicious hackers and they are consistently hacked for tens of millions of dollars. This is a global, industry-wide problem that demands our immediate attention.
These huge heists have a number of negative consequences. They lead to losses for ordinary holders. They also generate a great deal of negative coverage in the mainstream media, damaging the reputation of the industry as a whole. Lastly, they inhibit the adoption of blockchain technology more generally, as many people are reluctant to get involved in an industry that seems extraordinarily risky and insecure.
Decentralization is the solution. If every trader holds their own assets in their own wallet, there are never any massively lucrative wallets to target in the first place. Hackers can target individual users if they want, but that is true in all circumstances. In fact, it has been true since the advent of the Internet.
The blockchain industry must shift towards decentralized trading for its own survival. And for an exchange to be a true DEX, it must never take control of users’ funds. Each trader must retain control of his/her private keys throughout the entire trading process.
2. A DEX must be both a cross-chain and on-chain protocol.
An cross-chain swap is one that is made between two different blockchains. For example, if Alice trades 1 BTC to Bob in exchange for 150 LTC, this would be a cross-chain swap. The swap is occurring across two different blockchains.
Many DEX projects fail to meet this condition because they are designed exclusively for the Ethereum ecosystem. Users may be able to make swaps between tokens built on the Ethereum blockchain, but they cannot make swaps across different blockchains. For these token DEXs, there is no way to swap ETH or an ERC token for BTC or an asset of another protocol like, say, XMR or EOS.
As the name suggests, an on-chain swap is one that occurs on the blockchain’s ledger. This means that the transactions are submitted to and verified by each blockchain’s decentralized network, from each trader’s personal wallet.
This stands in contrast to a number of so-called decentralized exchanges, which actually settle trades through centralized order-matching nodes or smart contract accounts before submitting the transaction to any blockchains. In both cases, the swaps are not made on-chain. Rather, there is someone or something in the middle helping to facilitate the trade.
This structure reduces the decentralization of the exchange itself, since two individual traders are not transacting directly with one another. It also inevitably leads to additional security vulnerabilities and an increase in fees.
For instance, whenever swapping an ERC token, you must pay gas fees in ETH. This is true even if you're swapping an ERC token for a BTC protocol coin. Gas fee payments aren’t a flaw with any particular DEX protocol as much as they are one of the limitations of smart contract platforms in general, but this fact still makes smart contract DEXs inconvenient and costly from a user’s perspective.
Exchanges that allow on-chain trades are more decentralized, secure, and cost effective. They are also much harder to develop. That’s one of the primary reasons that many DEXs use off-chain order matching before settling the swap on-chain. But to be considered a true DEX, transactions must take place on-chain, even for assets from different platforms and protocols.
3. A DEX must be permissionless.
For a DEX to be truly decentralized, it must be permissionless. In other words, you shouldn’t need to be granted permission by a central authority to make trades on a true DEX.
There are two different dimensions to this idea of permissionless use.
First, a DEX must be accessible to everyone, regardless of their nationality or geographic location. If a DEX is actually decentralized, it is both theoretically and practically impossible to block anyone from using it. Some people refer to this property as “censorship resistance.”
Location-based censorship is already becoming a reality. For example, in July 2019, GitHub began locking the accounts of developers in Iran, Syria, North Korea, Cuba, and Crimea. In a statement to ZDNet, a GitHub spokesperson said that "GitHub is subject to US trade control laws, and is committed to full compliance with applicable law.”
Censorship of this nature would not even be possible on a truly decentralized exchange. And this would not create regulatory compliance problems because a true DEX is not subject to trade control laws. A true DEX is open source software that anyone can download and use.
The second dimension of permissionless software is the absence of registration processes. Users should never need to enter personal data or submit “know your customer” (KYC) documents, such as government identification, proof of employment, or bank records.
If an exchange is truly decentralized, then there is no central authority to decide who may or may not use the DEX. There is no central authority to collect user data and KYC documents to begin with. Any exchange that requires KYC is permissioned and therefore not decentralized.
A truly decentralized exchange is not a business, legal entity, or even an organization. A real DEX is simply a digital marketplace that connects individuals and allows them to transact with one another in a secure, fully peer-to-peer manner.
4. A DEX must be asset agnostic.
A truly decentralized exchange must allow direct trading trading between any two listed assets.
Most exchanges only offer a two or three trading pairs for each asset and those trading partners will inevitably be BTC, ETH, and perhaps a stablecoin. While Bitcoin and Ether have hundreds of trading pairs, most other assets have just two or three pairs.
There are several reasons why an exchange would want to limit the number of trading pairs each listed asset has. First, it quickly becomes much more difficult to manage all order books and trade settlements if every listed asset can be traded with any other.
With 6 listed assets, there would be a total of 15 trading pairs. With 15 listed assets, there would be 105 trading pairs. With 105 listed assets, there would be a 5,565 trading pairs. With 150 listed assets, it would be a whopping 11,325 trading pairs. This quickly gets out of hand.
There are now more than 2,000 different digital assets listed on CoinMarketCap so listing a few hundred of them on a single exchange is not unreasonable. In fact, many exchanges already support more than 100 assets. But it would be impossible for a centralized exchange to maintain active markets if there were tens of thousands of possible trading pairs.
Another reason that exchanges restrict trading pairs is to ensure ample activity and liquidity for all pairs offered. It would be extremely difficult to guarantee liquidity for thousands or tens of thousands of markets. Instead of taking on this enormous task, centralized exchanges simply corral traders into a limited number of trading pairs so that liquidity remains reasonably high.
However, for an exchange to be truly decentralized, it should not even have the ability to decide which trading pairs are accessible and which are not. A DEX must act as a free and open marketplace, allowing users to trade between any two listed assets. There may not be a willing counterparty to every trade offer but, at the very least, users have the freedom to post their desired offer in the first place.
AtomicDEX: The Industry’s First Real DEX
Komodo is the industry leader in DEX technology and the pioneer of atomic swaps. Atomic swaps are peer-to-peer trades of digital assets between one user and another.
Significantly, atomic swap technology is the only method for truly decentralized trading available in the blockchain industry today. Other protocols cannot meet the 4 core DEX requirements.
To recap, the 4 core requirements of a DEX are that it must be:
- both a cross-chain and on-chain protocol
- asset agnostic
If an exchange doesn’t meet these 4 criteria, then it cannot be considered a true DEX.
AtomicDEX is the only DEX in the industry that satisfies all 4 of these requirements. It supports non-custodial, peer-to-peer trading via Komodo’s cutting-edge atomic swap technology.
All trades are made on-chain and the AtomicDEX protocol works across different platforms and blockchain protocols. AtomicDEX is permissionless; anyone can use it without registering or submitting documents to a centralized authority. You can use it from anywhere in the world. Finally, AtomicDEX is asset agnostic and swaps can be made between any two listed assets.
AtomicDEX was recently moved into a public beta phase, which means that AtomicDEX is now available for anyone to download!
If you need a little help getting started with AtomicDEX, you can read the support guides on how to use AtomicDEX here. You can also watch this tutorial video on how to make an atomic swap with AtomicDEX.
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