Created in 2008 by the pseudonymous computer programmer Satoshi Nakamoto, Bitcoin is the first blockchain-based cryptocurrency. It was created as a peer to peer payment system that allows its users to transfer value with no third party or central authority involved. Since a network of distributed and mostly anonymous miners is all in charge of processing the transactions, the issues like fraud, censorship, and others are avoided.
The automated issuance mechanism of Bitcoin through mining also seeks to remove the control of money printing from banks that are privately owned and that lend money to the public and governments at an interest, creating the debt-based economy that led to the crash in 2008. This in turn led to the creation of Bitcoin. However, the primary goal of Bitcoin, to return the control of money to its owners, is in a way lost. Today, we entrust our Bitcoin with third party services daily, and the most popular of these services are exchanges.
Centralized exchanges are easy to use, easy to access and they are great for making quick trades. They also provide advanced trading functionalities like margin trading and others. However, they are also a great place for hackers to target, so they represent a security risk for your funds.
Centralized exchanges also provide a place for their users to store their cryptos. Even though it’s been said many times that using exchanges to store your cryptocurrency is not a good idea, still many people do it. This results in the popular exchanges becoming a honey pot for hackers to target, which has resulted in many people losing lots of money. Some exchanges are simply malicious or incompetent, practicing fractional reserve systems that can either lead to bankruptcy (the demise of mybitcoin), a voluntary elimination of the excess instruments (Mt. Gox hack from June 2011 or more recently Bitfinex hack), or a new investor bailout.
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Nevertheless, despite all these problems, we need to exchange our currencies. There are certain services and items that cannot be bought with Bitcoin (yet). That’s why, in order to acquire Bitcoin or cryptocurrencies, most people have to exchange it for a national currency. Furthermore, some cryptocurrencies like Bitshares or Ether have special tools and features that cannot be found in Bitcoin. So how to exchange coins without entrusting them to a third party service? The answer is simple. We can use decentralized exchanges.
What are Decentralized Exchanges?
Decentralized exchanges are the exchanges that do not require a third party to store your funds. Instead, you are always directly in control of your coins and you conduct transactions directly with whoever wants to purchase or sell your coins. This system can be achieved by creating assets (that can represent shares in a company for example) or proxy tokens (crypto assets that represent a certain fiat or crypto currency) or through a decentralized multi-signature escrow system, among other solutions that are currently being developed.
This system represents an alternative to the current model of centralized exchanges, where users deposit funds and get IOUs managed by the exchange. In this current model, when users ask to withdraw their funds, these are converted back into the cryptocurrency they represent and sent to their owners.
Benefits and Advantages
The most obvious benefit to using a decentralized exchange over a centralized one is that with a decentralized exchange there is no need to trust any single authority – it is a trustless service. This means that the funds are held by you in your personal wallet and not by a third party, so you are not required to trust the security or honesty of the exchange.
Another advantage to the decentralized exchanges is that they do not require you to give out your personal information. Users are not required to disclose their personal details to anyone, except if the exchange method involves bank transfers. In that case your identity is revealed only to the person that is selling or purchasing from you.
Furthermore, the hosting of decentralized exchanges is distributed through nodes. This means that with decentralized exchanges, there is no risk of server downtime.
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There are more benefits beyond these:
- Transparent and Open
All code that is used for running the network and all transactions occurring on the network are open source. Also, the live software is open to anyone anywhere to inspect, copy and improve upon.
- Efficient, Fast, Global, 24/7
A decentralized exchange is global service that is available to any member of the free internet, at every corner of the globe at all times of the day. This ensures transactions and settlement within seconds. Also, there is no need for brick and mortar institutions. This means that the cost of transactions can be 10x, 100x or even 1000x less than what they are with the traditional system.
- Incorruptibly Secure
In the traditional financial system the intermediaries are centralized institutions that can be corrupted, robbed, hacked, or coerced. Single points of failure can be catastrophic with such centralized systems. On the other hand, with a decentralized exchange everyone keeps control of their own keys to their own funds.
Read our comprehensive guide on best cryptocurrency exchanges.
Why Is This So Important?
Decentralized exchanges are efficient, transparent, available 24/7, fast, global and trustless, and that’s why they are so important. As the software develops it will become more user-friendly. It will offer innovative services that are difficult to imagine at this stage. With both decentralized exchanges and Bitcoin, the “internet of money” is quickly becoming a reality that will shape our future significantly.
Beyond these simple benefits and advantages, decentralized exchanges are important for deeper reasons as well, and I will highlight four reasons here:
- No more banking cartels
Everything is now in the open for everyone to see. This means that there is no need for large institutions to keep things private. In the traditional system, big institutions like banks, corporations and hedge funds could use security as an argument to keep all your information, as well as all their information, privately locked up and backed by their authority. On the other hand, the power of this new technology allows everything to be out in the open without compromising security.
- No more identity theft
In the traditional system, we give out our credit card information, private details, and even our keys and passwords to people we do business with. Through the power of cryptography this is no longer necessary. This new technology allows everyone to keep their personal details, information, and keys secure while proving that they have the right credentials.
- A platform for innovation
With collaborative services like Wikipedia, which is many times the size of even the best lexicons, we have seen an explosion of information on topics of all kinds. In the new digital age, we need not only to bring money to the internet, but to bring the innovative power of the internet to the services that money can provide: micropayments, smart contracts, and in short “programmable money”. This will unleash the exponential growth of information-technology into the realm of global, financial services.
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- Freedom for the unbanked
There is no reason any longer why the poor and unbanked should be banned from participating in the global economy. Our capitalist-minded financial services and their corrupt regimes no longer need to play an important part in their freedoms. With decentralized exchanges, anyone can store and transfer wealth at almost no cost, to anyone, anywhere in the world.
Downsides and Disadvantages
Some decentralized exchanges like Bitsquare require a user to be online in order for an order to be listed and for the trade to take place. This requires a user to perform certain actions like signaling that a payment was received.
Also, decentralized exchanges only allow the basic exchange of currency for a predetermined value, which means that trading features like margin trading, lending and stop loss are currently not available in the decentralized model.
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Furthermore, John McAfee, the technology security expert, wrote an article recently suggesting that decentralized exchanges make it more difficult to trace funds for the purpose of taxation, which could be a problem for government regulatory agencies. Maybe this is the reason why countries like South Korea and China have recently made moves to regulate cryptocurrency exchanges.
An Overview of Decentralized Exchanges
There is still a long way to go in order to build fully functional and convenient decentralized exchanges. However, there are several projects that have brought us the basic functions and an alternative way to trade currencies while keeping our funds safe from faulty business models, inside thefts, and hacks.
Here is the list of the some of the more popular decentralized exchanges:
- Bitshares and Openledger:Bitshares is the first decentralized cryptocurrency exchange. This platform has the best daily volume that has been around $14 million as of late, and it has its own native currency, Bitshares (BTS). Using the Bitshares platform, users can trade BTS, User Issued Assets (assets which can be issued by anyone to represent currencies, commodities, shares, and so on) and Market Pegged Assets (a crypto asset pegged to another commodity or currency which always has 100% or more of its value backed by the BitShares core currency, to which they can be converted at any time). Openledger is also on the Bitshares blockchain. This is where you can trade a decent number of different cryptos, and the daily volume on Openledger is about $3million.
- Bitsquare:Bitsquare is a decentralized open-source exchange that allows users to purchase and sell Bitcoin for national currencies and cryptocurrencies in a decentralized environment which means that the exchange itself does not handle funds nor can it be hacked. Users can purchase and sell Bitcoin without the need to entrust funds to middleman or third-party, meaning that the transactions occur directly between the buyer and seller. One more thing worth noting is that Bitsquare relies on a decentralized multi-signature escrow system to ensure that all trades are carried out in an honest, lawful and transparent way.
- CounterParty DEX:CounterParty(XCP) is decentralised financial platform and distributed open-source Internet protocol built on top of the Bitcoin blockchain and network that embeds data into regular Bitcoin transactions. It allows users to issue assets inside of the Bitcoin blockchain, and an asset that is created within the Counterparty protocol is often called a user-created token. When trading an asset for Bitcoin, the asset is held in escrow. The other user has to make a manual Bitcoin payment using the Counterparty wallet. On the other hand, when trading assets for other assets, the Counterparty protocol acts as a decentralized escrow service that holds the funds until the orders are matched.
- NXT:Nxt is a crypto exchange (one of the first crypto 2.0 projects), but unlike most exchanges, it is totally decentralized. This platform allows users to issue and trade assets, but these assets can only be exchanged for the coin NXT. Assets cannot be exchanged for other cryptocurrencies, and asset-to-asset exchange is also not possible.
- Cryptor Trust:Cryptor Trust is an investment vehicle for investing in Bitcoin and Crypto related assets, and is working on the Blockchain Asset Exchange (BAE), an open decentralized distributed platform for trading securities. Cryptor Trust is launching a new forum called Bitcoin Blockchain & FinTech with the username BlockchainForum on Telegram, and it also plans to list their own investment entities on the BAE exchange.
- Stashcrypto:Stashcrypto is an extremely fast and low cost off-blockchain system based on signed receipts. It is built on the Open-Transactions financial cryptography platform. When combined with Bitcoin, OT solves difficult issues in crypto finance. A user’s balance in OT cannot be changed without his signature, and receipts cannot be forged. OT is also able to prove which instruments are still valid, as well as to prove all balances, without storing any history except for the last signed receipt.
- EtherDelta – The objective of EtherDelta is to allow anyone to trade Ethereum-based tokens. This makes it a perfect solution for people looking to exchange cryptocurrency ICO tokens. Most exchanges either hold off on listing tokens or never do so because there just are too many from which to choose.
It is always good to see new decentralized exchanges pop up every now and then, because they provide us with the advanced features and ease of use that we so desire. Among these are the PAX (Pegged Asset Exchange), being developed by Komodo teams and the SuperNET, that allows users to exchange national currency assets with the privacy that zero-knowledge proofs provide, while the EasyDEX exchange will allow users to trade cryptocurrencies directly without resorting to proxy tokens. There is also the Waveplatform, which allows users to trade cryptocurrencies, fiat tokens, and assets (including asset-to-asset exchange).
The balancing act between individual user anonymity and security, government control, and protection from potential hacks and frauds, will likely continue for some time. Some countries have adopted different responses to the growing cryptocurrency industry. However, users who are concerned about digital currency theft may wish to explore their options within the decentralized services that allow users to be in charge of their money.
Decentralized exchanges provide global, frictionless value-transfers and many cryptocurrency enthusiasts think that they are the solution to the problems that Bitcoin exchanges currently pose. Without decentralized exchanges, there will always be intermediaries having control over the flow of value.
CaptainAltcoin's writers and guest post authors may or may not have a vested interest in any of the mentioned projects and businesses. None of the content on CaptainAltcoin is investment advice nor is it a replacement for advice from a certified financial planner. The views expressed in this article are those of the author and do not necessarily reflect the official policy or position of CaptainAltcoin.com