Decentralized exchange: Difference between revisions
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#REDIRECT [[Decentralized_finance#Decentralized_exchanges]] |
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A '''decentralized exchange''' ('''DEX''') is a [[cryptocurrency exchange]] which operates in a [[Decentralization|decentralized]] way, i.e., without a central authority. Decentralized exchanges allow [[peer-to-peer]] trading of [[cryptocurrency|cryptocurrencies]].<ref name="wsj">{{Cite news |url=https://www.wsj.com/articles/why-cryptocurrency-exchange-hacks-keep-happening-1531656000 |title=Cryptocurrency Exchanges Are Getting Hacked Because It’s Easy |last=Russolillo |first=Steven |date=2018-07-16 |work=Wall Street Journal |access-date=2018-09-11 |last2=Jeong |first2=Eun-Young |language=en-US |issn=0099-9660}}</ref>[[File:Switcheo ledger.png|thumb|Ledger login on Switcheo Exchange|alt=]]Because users do not need to transfer their assets to the exchange, decentralized exchanges reduce the risk of theft from [[Cryptocurrency and security|hacking of exchanges]].<ref>{{Cite news |url=http://www.digitaljournal.com/business/big-investment-in-cryptocurrency-startup-altcoin-io/article/531556 |title=Big investment in cryptocurrency startup Altcoin.io |last=Sandle |first=Tim |date=2018-09-09 |work=Digital Journal |access-date=2018-09-11}}</ref><ref>{{Cite news |url=https://www.wsj.com/articles/alexis-ohanians-vc-firm-invests-2-1-million-in-crypto-trading-platform-1520365270 |title=Alexis Ohanian’s VC Firm Invests in Crypto Trading Platform |last=Castellanos |first=Sara |date=2018-03-06 |work=Wall Street Journal |access-date=2018-09-11 |language=en-US |issn=0099-9660}}</ref> Decentralized exchanges can also prevent price manipulation or faked trading volume through [[wash trade|wash trading]], and are more anonymous than exchanges which implement [[know your customer]] requirements. |
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Decentralized exchanges come in two primary flavors, push and pull with a third type "co-operative" which has fallen out of favor due to inherent security issues. |
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A push system is the least common because it is the most difficult for developers to build, test and deploy. However with a push system, a "deposit" address is is created on the blockchain of the input currency. This deposit address represents a permanent order to trade at market price for a given pair. Any funds deposited to the address are automatically traded at current market rates and forwarded to the withdrawal address. This is similar to how the centralized exchanges such as [https://shapeshift.io shapeshift] and [https://changelly.com changelly] work except that the functionality is distributed to worker nodes who are paid a fee for facilitating the transaction. The primary advantage of this is that the user can accept funds in any cryptocurrency or token, even ones that may be less than desirable, and they will receive funds in the currency specified by the standing order, all with no more hassle than giving out a normal address. With this system, the user does not need to be online to receive funds. Any funds transiting the address are automatically swept out, converted and forwarded. At the time of this writing only [https://www.tqnext.com tqnext] has this capability in a fully decentralized manner. |
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The pull system is far more common. In a pull system the user or the exchange software creates a [[Multisignature|multisignature wallet]] the user then deposits funds to the wallet and initiates a trade by placing an order for up to the funds deposited. The advantage is that the user can control the pricing they receive. As long as the centralized keystore element of the exchange remains intact then there is little risk to user funds and the centralized keystore is generally on a service such as AWS Lambda with no actual centralized server. This minimizes the attack surface compared to centralized exchanges many of which run on clusters of PHP or Ruby servers with almost no separation between the web interface and the crypto currency wallets. Most decentralized exchanges are of the pull type with the oldest being [https://openledger.io/ openledger] which has been in continuous operation since 2016. |
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A third flavor exists and this is "cooperative", but cooperative exchanges can be sibyl attacked fairly easily and this places user funds at dire risk. Nevertheless it is worth describing how co-ops work. With a co-op each user participates in a peer to peer message passing network. The subject of the messages are generally offers to buy or sell, with some proof of liquidity such as signing the offer with the private key which controls a particular address. Once an offer is accepted, the funds are transferred into a mutually controlled multisignature wallet, created by and controlled by both parties. As soon as each side sees that the other side has deposited funds, then each side signs a "release notice" releasing funds. This works so long as both parties are honest. But an attacker could easily fail to sign the required release notice, thereby locking up the effected parties funds indefinitely. A timer could be applied to the multisignature wallet to return funds to source if a release is not made within x minutes, but this too is a security issue. Finally escrow agents, supposedly independent third parties could be added to the transaction to ensure fidelity of both parties to the terms of trade, however in a fully decentralized anonymous system it is impossible to assure that the agent is not working for one party or the other and a reputation system could easily be gamed. For this reason, and for the fact that a user must remain online in order to complete a trade, co-operative exchanges tend to struggle if not fail outright. As a result all known fully co-operative systems are presently offline or have such thin order books that they struggle to attract customers. |
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There are some signs that decentralized exchanges have been suffering from low trading volumes and [[market liquidity]].<ref name="wsj" /> The 0x project, a protocol for building decentralized exchanges with interchangeable liquidity attempts to solve this issue.<ref>{{Cite news|url=https://techcrunch.com/2018/07/16/0x/|title=0x lets any app be the Craigslist of cryptocurrency|work=TechCrunch|access-date=2018-11-24|language=en-US}}</ref> Totle is another project trying to remedy the lack of liquidity by pooling together leading decentralized exchanges and routing users' trades according to best price. <ref>{{Cite news|url=https://www.cryptoninjas.net/2018/12/19/dex-aggregation-platform-totle-out-of-beta-with-launch-of-full-api/|title=DEX aggregation platform totle out of beta with launch of full|work=CryptoNinjas|access-date=2019-03-11|language=en-US}}</ref> |
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== Drawbacks == |
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Due to a lack of [[Know your customer|KYC]] process, and no way to revert a transaction, users are at a loss if they are ever hacked for their passwords or private keys.<ref>{{Cite web|url=https://www.bloomberg.com/news/articles/2018-01-30/record-crypto-heist-raises-the-appeal-of-a-new-type-of-exchange|title=Bloomberg - Record Crypto Heist Raises the Appeal of a New Type of Exchange|website=www.bloomberg.com|access-date=2018-11-17}}</ref> However this is a known quantity for all cryptocurrencies since the earliest days. If you lose your keys you lose your coins. The main point here being user accountability. A user should not suffer a loss because of sloppy security practices on behalf of the exchange, and thus keeping control of keys is the primary reason to use a decentralized exchange, second only to the lack of AML/KYC, which is not necessary for peer to peer trading and is detrimental for users in countries with tightly controlled financial markets where only corrupt parties are permitted to participate in the exchange of funds. Ergo these drawbacks can be thought of as strengths, so long as the user is aware of their own responsibilities in managing their keys. |
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== Degrees of Decentralization == |
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A decentralized exchange can still have centralized components, whereby some control of the exchange is still in the hands of a central authority. A notable example being IDEX blocking New York State users from placing orders on the platform.<ref name=":1">{{Cite tweet |user=Aurora_dao |number=1054917418621984768 |date = 23 Oct 2018 |title= #IDEX will begin blocking new orders from users with New York State IP addresses on Thursday, October 25th (6pm UTC). Cancels and withdrawals will remain active. }}</ref> With the ability to block trades and traders they are not fully decentralized and this comprises the bulk of "decentralized exchanges" while platforms such as [https://www.tqnext.com tqnext] and [https://openledger.io/ openledger] run entirely clientside and there truly is no middleman or infrastructure which can be hacked assuming the user's own computer has no viruses or malware. |
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In July 2018, decentralized exchange Bancor was reportedly hacked and suffered a loss of $13.5M USD in assets before freezing funds.<ref name="bancor-freeze-loss">{{Cite web|url=https://www.zdnet.com/article/another-hack-rocks-cryptocurrency-trading-bancor-loses-23-5-million/|title=Another hack rocks cryptocurrency trading: Bancor loses $13.5 million|last=Osborne|first=Charlie|website=ZDNet|language=en|access-date=2018-12-13}}</ref> In a Tweet, [[Charlie Lee (computer scientist)|Charlie Lee]], the creator of [[Litecoin]] spoke out and claimed an exchange cannot be decentralized if it can lose or freeze customer funds.<ref>{{Cite web|url=https://techcrunch.com/2018/07/10/bancor-loses-23-5m/|title=The crypto world’s latest hack sees Bancor lose $23.5M|website=TechCrunch|language=en-US|access-date=2018-12-13}}</ref> |
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Operators of decentralized exchanges can face legal consequences from government regulators. One example being the founder of EtherDelta, who in November 2018 settled charges with the [[U.S. Securities and Exchange Commission]] over operating an unregistered securities exchange.<ref>{{Cite web|url=https://www.reuters.com/article/us-etherdelta-sec/sec-etherdelta-founder-settle-charges-over-operating-unregistered-exchange-idUSKBN1ND2CC|title=SEC, EtherDelta founder settle charges over operating unregistered exchange|website=Reuters|language=en-US|access-date=2018-06-05}}</ref> |
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== Reference == |
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{{Reflist|30em}} |
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{{Cryptocurrencies}} |
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[[Category:Digital currency exchanges]] |
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Latest revision as of 10:34, 7 May 2022
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