"It's true that contemporary technology permits decentralization, it also permits centralization. It depends on how you use the technology."
– Noam Chomsky
Although Bitcoin was the spark that started the cryptocurrency phenomenon and kindled the emerging decentralized revolution, you won't find the words decentralized or decentralization anywhere in the Bitcoin whitepaper. Even so, the general spirit of decentralization that permeates its pages has inspired many subsequent projects.
Nearly a decade after the creation of Bitcoin, the ecosystem has built over a thousand decentralized cryptocurrencies, yet decentralized cryptocurrency exchanges are scarce. In fact, many aspects of popular cryptocurrency exchanges are highly centralized, creating risk that comes with single points of failure and continuing the status-quo of consolidated financial institutions.
By recapturing some of the early decentralist idealism and distilling those concepts into digital platforms for truly peer-to-peer marketplace trading, the decentralized exchanges taking shape at the start of 2018 not only align themselves with core crypto-principals, they also mimic the evolutionary story of fiat currency exchanges.
It's time for the ecosystem to answer a fundamental question that has been looming over our heads since bitcoin's first exchange rate was calculated in 2009 – does cryptocurrency need decentralized exchanges?
Cryptocurrency's Centralization Paradox
Centralized cryptocurrency exchanges like Poloniex, Bitfinex, GDAX, Kraken, and Gemini provide excellent fiat on-ramps into the cryptospace, accounting for billions of dollars' worth of transactions last year. However, the centralization inherent in these exchanges means that when users allow these institutions to hold their assets, they are sometimes at risk.
According to one Cambridge University study from 2017, 73 percent of exchanges "take custody of user funds" with little to no oversight, all the while providing bad actors with the convenience of a single point of failure. Hacks have plagued centralized cryptocurrency exchanges from their inception and continue to do so. Some exploits have even gone relatively unnoticed, and consequently unexploited, despite lurking in the computer code.
While the retention of control over funds is often cited as one of the main reasons for pursuing decentralized cryptocurrency exchanges, they offer far more than that. Increased levels of anonymity, faster and less expensive transactions, integrations with secure hardware wallets, and less accessible attack vectors for black-hat hackers are all part of the advantages that can come from decentralized exchanges.
So, why are they so few and far between?
The Paradigm Shows Decentralization Takes Time
Cryptocurrencies live on distributed ledgers for a reason. While cryptographically-secured digital money was a significant milestone in the evolution of pecuniary technologies, it remained "incomplete without a way to prevent double-spending," as penned in the Bitcoin whitepaper.
This is why subsequent blockchain and other distributed ledger technology (DLT) projects have been extrapolated from Bitcoin and used to create the basis for the entire decentralized revolution, most prevalently in the financial sector. While cryptocurrency's foray into finance might just be starting, the concept of decentralization is a well-known and welcome ideology already present within the realm of fiat currency exchanges.
If there is a world standard for a decentralized currency exchange, it is the fiat Foreign Exchange Market or Forex where desktop traders, central banks, and everyone in between meets to buy and sell the fiat currencies of the world. While Forex trading has become integral to the functioning of the international financial system, the decentralized exchanges that are available for cryptocurrency trading are hardly vital.
Forex's roots can be traced back to post-war international trade cooperation in the aftermath of World War II. Created under the leadership of the International Monetary Fund at a 1976 meeting in Jamacia, Forex established a new international financial order. This was based on floating exchange rates instead of the fixed exchange rate systems that had conceptually failed under market pressures.
Forex might be the world's largest exchange, but it has only become so recently, largely due to the flourishing of the internet and international regulatory cooperation. Like with the Forex, many of the regulatory concerns surrounding cryptocurrency are also beginning to receive growing international attention by standards bodies and supranational organizations.
Where the Paradigm is leading the Ecosystem
Similar to how the printing press decentralized knowledge in the 1400s, which had previously been limited to governments and religious institutions, the advent of blockchains dispersed the ability to create currencies. Yet, without decentralized exchanges to trade cryptocurrencies on, mass adoption will be hampered.
Until relatively recently, mass adoption has overwhelmingly been about the ease of use provided by centralized exchanges, some of which even have smartphone apps. Juxtaposed to this instant gratification is the maze of EDCC's, or smart contracts, one must navigate to interact with the rudimentary decentralized exchanges that have existed up until now. Additionally, having direct control over your own funds means managing your own key security, and many marketplace platform trading features (e.g., stop loss orders) have been sorely lacking from the available decentralized exchanges.
One Ethereum project is attempting to tackle the decentralized exchange issue. The 0x protocol relieves some of the technological hurdles facing decentralized exchange.
Orders using 0x aren't allowed to clog Ethereum with transactions or on-chain order booking. Rather, blockchain gas costs are reduced by transporting the orders off chain. There, relayers are incentivized to broadcast them by collecting a small fee every time they help facilitate a transaction. And because anyone can build a relayer using 0x, it is an important step in decentralization.
One day, there may be a global, decentralized cryptocurrency exchange capable of handling volumes far in excess of the Forex. If such a system is ever created, it will be predicated upon the same trend of decentralization that created the Forex. That system could potentially encompass attributes of decentralized exchanges and protocols currently redefining cryptocurrency trading at the start of 2018.
Does cryptocurrency need decentralized exchanges? Like with all of human technology, it mostly depends on what we want out of it.