The Background: What is an Exchange & How do they Work?
Traditionally, the process of trading in one currency for another required the services of an exchanger. This person would hold a wide range of currencies and would provide a central point that people could go to, whichever of those currencies they wanted to buy and sell. This person would always be willing to buy or sell any of the currencies they traded, and because this entailed significant risk of the value changing and leaving them with a lot of lower value currency, their price would include a substantial mark-up on the real value of each currency.
It is only because of the very large scale of their operations that financial institutions such as banks are able to provide this kind of service for national fiat currencies for only a moderately high spread (mark-up).
Currency exchange websites with peer to peer order books offer an improvement on this situation. They do this by directly matching a person wanting to sell currency A for currency B with another real person wanting to sell currency B for currency A. This allows both parties to enjoy a better price, and also makes for a more transparent marketplace. Most cryptocurrency exchange websites, where users can trade cryptocurrency for fiat or exchange one cryptocurrency for another, operate like this.
The Problem: Why You Need a Decentralized Exchange
The problem with this kind of exchange is that each person must give their money to the exchange first. Although one user may have their order directly matched against that of other users, there is no direct transfer of funds between the two people. Instead, they each give their money to the exchange, the order matching process adjusts the balance which each one holds at the exchange, and then they each request a withdrawal. There are two problems with this. Firstly the central service provider – the exchanger – will inevitably still charge a significant fee for their service. Secondly, they what’s known as a central point of failure. This means that whilst holding onto other people’s coins they may be robbed, leaving all of their customers out of pocket. They may also be tempted to steal their customers funds themselves, perhaps believing they could hide this theft through fractional reserve practices. This has happened time and time again, to many of the world’s largest Bitcoin and alt coin exchanges, including Mt. Gox, Bitstamp, and Bter.
The Solution: The Making of a Decentralized Exchange
The most effective solution to the common problem of having a central point of failure is decentralization. This case is no exception. The most secure type of exchange is one where each user retains control of their own finances until a trade is made directly with another user. There should be no central server required, and no central service provider.
This is difficult to achieve because you also need to make sure that dishonest users cannot steal from everybody else. Usually, in any trade, one person must make the first payment. In a peer to peer trade over the internet this is risky, because the other person may simply take your money and not send you anything in return.
There are various solutions to make the creation of a decentralized cryptocurrency exchange possible. For example, one solution may be to break up the payment into many smaller micro-transactions. Each person could then send a very small amount, wait for the other person to reciprocate, send another very small amount, and so on.
Decentralized Bitcoin & Cryptocurrency Exchanges
- Multisigna – Uses multisig for anonymous decentralized exchanges.
- BlackHalo – The world’s first working decentralized exchange created by the BlackCoin team. The functionality of BlackHalo is also being extended by NightTrader, which will offer a more conventional and convenient ‘trading floor’ experience.
- MercuryEx – Uses the cross-chain atomic swap protocol. Alpha release available.
- B&C Exchange
- Blocknet Exchange
Decentralized Asset Exchanges
The following services allow for the decentralized trading of crypto assets created on the same blockchain / ledger as the service itself, but do not allow for trading between blockchains in a decentralized fashion. This is not intended to be an exhaustive list as an asset exchange is easier to achieve than cross-blockchain trading, and is therefore more common. If you would like to suggest another services for inclusion in the list, however, I would be happy to oblige if you leave a comment explaining your suggestion.« Back to Glossary Index