Due to several security risks such as system hacking and exit scams, decentralized exchange or DEX has caught the attention of several companies and individuals in the digital currency space. There are several projects in the works to get cryptocurrencies to try and replace the standard virtual-only digital currency exchanges. These projects focus on tokens or utilizing the blockchain technology.
One company, however, is proposing a new alternative to the current decentralized exchange markets. Decred is looking to facilitate the exchange using only cryptocurrencies instead of fiat currencies. The company is offering a service that is structured by the client and server which doesn't rely so heavily on a similar blockchain or token. Decred has envisioned a system where the operators of the server never take ownership of the users funds.
The proposed project offers a program where the operators won't collect any fees on matching orders. Plus, the orders taken on the new DEX exchange can be regulated internally. Of course, there will be rules that are applied and enforced.
Decred will deal with malicious clients by implementing a system that is structured off of Politeia. To discourage malicious behavior the company is requiring an upfront payment in order for a new client to create an account on their server.
Decred has a full list of properties that they would like to include to create this alternative decentralized exchange. With Decred's proposal, and is suggesting smaller orders use the LN network which operates off-chain with atomic swaps.
The new infrastructure that Decred is proposing will help to improve the digital currency ecosystem that is currently in place.
The Motivation Behind The New Decentralized Exchange
Anyone who has ever tried to introduce new cryptocurrencies to the exchange market knows there are several hoops to jump through. Operators that deal with centralized exchange markets understand that to take ownership of funds, specific rules and laws must be followed.
Compliance and registration to regulatory agencies such as FinCEN takes time. Of course for the clients dealing with centralized exchanges, there is the issue of invasion of privacy due to the KYC/AML policies.
It is also well known that client funds can be placed on hold or even frozen for any reason. It is also a known fact that projects seeking to add cryptocurrency to the exchange markets often come at a substantial fee for listing to the network. Most of the larger exchanges will only list is certain cryptocurrencies that will generate higher profits.
Many DEX projects have shown to be successful to varying degrees using tokens or blockchain technology. However, they have only been able to address some of the issues. And while many of these DEX projects are removing the third-party, there is still trading fees within their systems. And while these fees no longer go to third parties but remain within the company itself, it still is counterproductive to a network of open source exchange.
Present challenges from the user experience, technological perspectives, regulatory, are still susceptible to HFTs or high-frequency trading nodes. Since the 1990s HFT's have a huge influence in equity, forex, and commodity. This influence has been noted as “flash crashes.” The flash crashes are the result of HFT's pulling they're liquidity from the market all at once.
HFT's go to the extreme measures of having a delay in data transfer than their competitor. While many say that HFT's is a positive thing by offering liquidity to the exchange markets, that liquidity can vanish at a moment’s notice.
HFT's have been able to distort the costs of assets which they trade to come out on top. They are also known to sabotage the price discovery process. Due to many of each HFTs that are operated or possibly funded by investment banks, and other financial institutions can exert influence over the digital currencies.
How To Make DEX A Reality
There is some basic practical ideas to make DEX a reality. By implementing atomic swaps, it is plausible to utilize trustless exchanges. To maintain a ledger of transactions, there has to be a platform where the users can correspond with one another about prices. Of course, there are always users that will submit fraudulent claims. To circumvent these orders, there needs to be a way for users to prove they can control and regulate the funds there orders relate to.
There also needs to be a mechanism in place where users are able to receive and transmit the limit of exchanges so that the orders placed can be matched. To achieve a fully functional DEX, it would be plausible, to begin with a simple structure that revolves around the client/server. Once that is established the server could be extended and have it relate orders between different servers which creates a mesh.
Decred And The Future Of DEX
Because Decred is a late arrival to DEX projects, they are able to understand and utilize the best of what has come before. Decred has taken the stance that extracting fees from trades using a blockchain or tokens is the wrong initiative structure.
The idea is to become a genuinely decentralized exchange. Of course, the company will be implementing a small fee for creating a new account, this will help sort out those with malicious intents to jeopardize the ecosystem. Clients with dishonorable intentions whose accounts get banned will have to pay this fee repeatedly to set up a new account.
According to Decred, the fee that is in place will not be scaled due to volume but is intended to act as a spam deterrent as well as offsetting some of the costs to operate the DEX server. The site has also made it known that the DEX will not be a blockchain. However, there will be specific rules that must be followed for Decred's DEX to work correctly.
It is imperative that specific rules be followed precisely. Such as the rule that the orders must correspond to signed messages. These messages will demonstrate control of a corresponding amount of unspent coins. A valid order will require that the coins have not moved on-chain for over 24 hours. While there are other rules in place, it is important to note that the rules are voluntarily enforced.
It is quite clear that by using the existing cryptocurrency infrastructure, it can be done. By elaborating on the technology already in place, making the exchange process permissionless, and removing the gatekeepers as well as all barriers to entry, the proposal that Decred has set forth takes in all considerations for how an ideal DEX should operate.
Decred is offering a platform that is truly decentralized with minimal fees, less censorship, and that excluding HFTs. Many people will find this proposal to be a true decentralized exchange. You can read the full plan on Decred's blog if you or your company is interested in collaborating with Decred and build the DEX.