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#REDIRECT [[Decentralized_finance#Decentralized_exchanges]] |
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{{Short description|Type of cryptocurrency exchange}} |
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[[File:Dex Liquidity Curve.png|alt=|thumb|Graph of basic pricing function commonly used by liquidity pool exchanges ]] |
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'''Decentralized exchanges''' ('''DEX''') are a type of [[cryptocurrency exchange]] which allows for direct [[peer-to-peer]] [[cryptocurrency]] transactions to take place [[online]] securely and without the need for an [[intermediary]]. |
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== Overview == |
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In transactions made through decentralized exchanges, the typical third party entities which would normally oversee the security and transfer of [[Asset|assets]] (e.g. [[Bank|banks]], [[Stockbroker|stockbrokers]], online [[payment gateways]], government [[Institution|institutions]], etc.) are substituted by a [[blockchain]] or [[distributed ledger]]. Some common methods of operation include the use of [[smart contracts]] or order book relaying, although many other variations are possible and with differing degrees of [[decentralization]].<ref name=":0">{{Cite web|last=Wong|first=Joon Ian|title=Coinbase bought a "decentralized" crypto exchange. How does that work?|url=https://qz.com/1289262/what-are-centralized-and-decentralized-cryptocurrency-exchanges/|access-date=2020-12-03|website=Quartz|language=en}}</ref><ref>{{Cite news|date=2017-09-28|title=This 31-Year-Old Is Trying to Revolutionize Cryptocurrency Trading|language=en|work=Bloomberg.com|url=https://www.bloomberg.com/news/articles/2017-09-28/upending-digital-currency-market-is-next-act-for-ex-virtu-trader|access-date=2020-12-03}}</ref> |
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Because traders on a decentralized exchange often do not need to transfer their assets to the exchange before executing a trade, 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> but liquidity providers do need to transfer tokens to the decentralized exchange. 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]] (KYC) requirements. |
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There are some signs that decentralized exchanges have been suffering from low trading volumes and [[market liquidity]].<ref name="wsj">{{Cite news|last1=Russolillo|first1=Steven|last2=Jeong|first2=Eun-Young|date=2018-07-16|title=Cryptocurrency Exchanges Are Getting Hacked Because It's Easy|language=en-US|work=Wall Street Journal|url=https://www.wsj.com/articles/why-cryptocurrency-exchange-hacks-keep-happening-1531656000|access-date=2018-09-11|issn=0099-9660}}</ref> The [[0x (decentralized exchange infrastructure)|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> |
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Decentralized Exchanges are usually built on open-source code, indicating that anyone interested can see precisely how they work and they can use the codebase to add new functionality. <ref>{{Cite news|url=https://thecryptojournal.substack.com/p/decentralized-finance|title=Introduction to Decentralized Exchanges|work=TheCryptoJournal|access-date=2022-04-18|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> |
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Although liquidity pool DEX are the most widely used, they may have some drawbacks. The most common problems of liquidity pool DEXes are price slippage and [[front running]]. |
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'''Price slippage''' occurs because of the AMM (Automated Market Makers) nature itself — the larger the deal, the stronger impact it has on the price. For example, if the constant product AMM is in use, every deal must keep the product xy = k constant, where x and y are quantities of two cryptocurrencies (or tokens) in the pool. So the larger is the input amount Δx, the lower is the final ratio y / x that gives an exchange price. The problem is mostly significant for large deals or small liquidity pools. |
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'''Front running''' is a special type of attack in public blockchains when some participant (usually a miner) seeing an upcoming trading transaction puts his own transaction ahead (playing with a transaction fee for example), making the initial transaction less profitable or even reverted. |
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Ideas of improving front running resistance of the constant product AMM were first discussed in a post by [[Vitalik Buterin]].<ref>{{Cite web|url=https://ethresear.ch/t/improving-front-running-resistance-of-x-y-k-market-makers/1281|title=Improving front running resistance of x*y=k market makers|website=Ethresear.ch|language=en-US|access-date=2021-01-27}}</ref> |
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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> |
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In July 2018, decentralized exchange [[Bancor (cryptocurrency)|Bancor]] was reportedly hacked and suffered a loss of $13.5M 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 is 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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[[Uniswap]], which is built upon the [[Ethereum]] blockchain, has the largest trading volume of any DEX.<ref>{{Cite news|last=Gerelyn|first=Terzo|date=May 25, 2021|title=Uniswap Shines on Top-10 CryptoLeaderboard With Double-Digit Gains|work=Yahoo Finance|url=https://finance.yahoo.com/news/uniswap-shines-top-10-crypto-145756688.html}}</ref> It deployed its V3 to the Ethereum mainnet on May 5th 2021. |
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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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