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Decentralized Crypto Exchanges: A Viable Option?

May 16, 2018

Decentralization is a defining characteristic of cryptocurrencies and is an attractive structure for crypto traders. Unlike fiat currency, there are no central banks or large individual institutions imposing significant controls and policies over the crypto market. Ironically, while “decentralization” is a core feature of cryptocurrencies, in practice, the most widely utilized exchanges for trading cryptos are centralized ones such as Coinbase and Kraken. 

Eliminating the “middle-man” frees investors from a reliance on third-parties to manage funds or process coin transactions. Currently, centralized exchanges are the most popular due to their developed infrastructure, which supports clients’ investing objectives. As Ian Allison suggests in his piece “The Next Generation of Crypto Exchanges Has One Big Missing Piece”, there are some significant challenges. However, decentralized trading platforms are gaining momentum. This may eventually reduce the dependency on exchanges such as Coinebase.  

AirSwap is a platform that allows clients to use a bulletin-board style of format to conduct trades. It is a peer-to-peer focused system, where traders post their intent to trade, and smart contracts are used to ensure the trade is cleared. There is no third party directly involved because the traders are interacting with each other directly and investors are simply using AirSwap as a medium of exchange. AirSwap handled over $1 million worth of transactions on its first day, demonstarting the demand for decentralized exchanges.

Another alternative to centralized crypto exchanges was created is KyberNetwork. Kyber maintains a crypto reserve cryptocurrency pool which is controlled by a smart contract. Kyber works by allowing an investor to send 1 cryptocurrency to the Kyber pool, where it can be exchanged (based on Kyber exchange rate, plus a small fee) into the cryptocurrency desired by the receiver. 

Although AirSwap and KyberNetwork are innovative alternatives to the traditional exchanges, there are obstacles that must be overcome before decentralized exchanges can truly become a feasible alternative to centralized exchanges. 

Decentralized exchanges can only transact in cryptocurrencies, which must first be purchased on centralized exchanges, and users are unable to make trades using fiat currencies. 

Attracting liquidity is also a limiting factor to decentralized exchanges, as decentralized exchanges must provide traders with the liquidity necessary to meet trader’s demands. The concern arises from the fact that liquidity begets liquidity, and initial momentum on which the exchange can build is needed.  

Though there is seemingly strong interest from cryptocurrency investors for the services provided by decentralized exchanges, there are challenges that must be addressed before these exchanges can become realistic alternatives.