Have Decentralized Exchanges—often abbreviated to DEX—lived up to their promise? On paper, they sound perfectly matched to the democratic, DIY spirit of cryptocurrency. In their groundbreaking 2008 paper, Satoshi Nakamoto conceptualized Bitcoin as a tool for peer-to-peer payments “without going through a financial institution.” Blockchain’s decentralized nature attracted early adopters and continues to garner additional users looking for an alternative to powerful centralized institutions.
Nakamoto first conceptualized a singular blockchain cryptocurrency (Bitcoin), but there are now over 1,500 cryptocurrencies in existence. A typical user might hold some Bitcoin in reserve on a hardware wallet, some Bitcoin Cash in a mobile wallet for day-to-day merchant purchases, and a host of utility tokens to use in different platforms. Exchanges are vital to maintaining this multi-currency crypto landscape. Yet centralized exchanges, controlled by powerful companies bearing a close resemblance to the financial institutions Nakamoto sought to escape, play a role in most crypto trades. One analysis found that one of the most popular decentralized exchanges, IDEX, processed 69,339 trades over two weeks. Popular centralized exchange Bitfinex, by contrast, facilitated 92,024 trades over two days.
Why have decentralized exchanges struggled behind centralized ones—and why do so many crypto users passionately advocate for them, anyway? Let’s take a look:
Decentralized Exchanges: The Pros and Cons
Whenever a trader uses a centralized exchange, they’re essentially handing their money over to someone else. These exchanges hold large wallets where users deposit the funds they’d like to have available for trades. A ledger tracks who owns which funds, updating whenever two traders swap currencies. Unsurprisingly, these exchange wallets are irresistible to crypto thieves. Hackers stole a stunning $731 million worth of crypto from exchanges during the first half of 2018.
Due to their concentrated processing power, centralized exchanges are also vulnerable to censorship, technology downtime, and other snags: the moment something happens to back-end operations, the entire exchange collapses. Centralization has helped the Chinese government block public access to over 100 crypto exchanges. A handful of exchange operators have also (unfortunately) demonstrated some of the security issues inherent in centralized exchanges. The founder of popular altcoin exchanges Moolah and MintPal abruptly shut both sites down in 2014—but now he’s accused of absconding with many users’ crypto stored in the central exchange wallet.
There are many different decentralized exchange models, but they all share one important design feature: they distribute essential exchange activities across many nodes, replacing a single processing point with a dispersed, resilient network. CoinMarketCap delineates a few of today’s most prominent decentralized exchange models, including 0x relayers (a complicated methodology use smart contracts to handle orders while allowing direct peer-to-peer crypto transfers), simplified DEXs (a simple order book strategy that suffers from price discovery issues), and withdraw/deposit (a borderline-centralized strategy that has users deposit funds into a shared smart contract).
Decentralized models limit their users’ exposure to the threats of centralization, but they can also come with significant drawbacks. While mainstream, centralized exchanges such as CoinBase center user-friendliness to attract new crypto adopters, decentralized exchanges often rely on more complex mechanisms that make participation difficult for beginner or even intermediate crypto users. Speed can be a challenge for DEXs. Blockchain is currently wrestling with scalability challenges, and user bottlenecks in decentralized exchanges that rely on blockchain processing power can result in significant trade delays. Slowdowns aren’t just a minor annoyance—in the volatile crypto market, delays can result in substantial price differences and users missing out on high-quality trades.
CoinMarketCap points out that virtually all decentralized trades traffic in only Ethereum and Ethereum-based coins. While that makes DEXs a great destination for altcoin enthusiasts, it also means that most DEXs don’t handle in-demand trading pairs such as BTC/USDT. A new crypto user who wants to use fiat to trade altcoins on a decentralized exchange must participate in a minimum of two exchanges. Each transfer and trade in this step takes time and fees, which further renders DEXs unattractive to new users. Because DEXs serve a relatively small market, they feature low liquidity. A single large order can drastically change the pricing and availability dynamics of a low-liquidity exchange.
A Hybrid Solution
There’s clearly interest in greater use of decentralized exchanges. No less a figure than Ethereum founder Vitalik Buterin recently told a crowd that centralized exchanges should “go burn in hell.” But the sad reality is that decentralized exchanges aren’t there yet. Every DEX on the market serves up a major disadvantage that limits its adoption rates, whether that’s low liquidity or a painfully slow processing time.
At Amplify, we believe the way forward is a hybrid solution: an exchange with both decentralized and centralized features. That’s our model for the Amplify Exchange.
Amplify Exchange features two parts. Amplify Distributed will function largely as a traditionally centralized exchange, allowing it the speed and flexibility to respond quickly to trade orders and provide a wide range of trading pairs. Amplify Bridgechain is a blockchain digital ledger that mirrors the activities of Amplify Distributed, providing an immutable, tamper-proof record of exchange activities.
The Amplify Bridgechain isn’t just special because it provides a blockchain record of off-chain activities. Transaction processing on the Amplify Bridgechain will be distributed across SubstratumNodes that also activate Amplify Exchange Nodes. SubstratumNodes provide censorship-proof, distributed, peer-to-peer internet access, rewarding node operators with SUB tokens in exchange for handling routing requests. Amplify Exchange Nodes process transactions over the same distributed network, rewarding operators with the AMPX tokens. A unique proof-of-stake consensus mechanism incentivizes nodes to participate in adding blocks to the Bridgechain.
The Bridgechain renders Amplify resistant to censorship, technical failures, and theft, turning a centralized point of failure into a resilient, vibrant network. Its mirror, Amplify Distributed, provides the user-friendliness of a centralized exchange. Amplify adopters will also enjoy a highly customizable dashboard with tools for both beginning and advanced traders, trading pairs that include dozens of popular altcoins, and direct fiat-to-altcoin conversions.
Decentralized and centralized exchanges both offer unique advantages and disadvantages—which is why a hybrid solution is the next step forward for cryptocurrency. Amplify is setting out to offer an exchange with the best of both worlds.