Decentralized exchanges, or DEXs, seem to have become lost in the shuffle that is the fast-changing world of digital assets.
Debate over whether the market or regulators would support DEXs, which are pure peer-to-peer electronic marketplaces without the structures or limitations of a conventional, centralized venue, have faded from discussion.
The big news for blockchain-based finance in 2019 was Facebook’s Libra and decisions by governments, including China’s, to launch central-bank digital currencies; prospects for securities (regulated) tokens; the licensing of crypto banks in Switzerland and Hong Kong’s paving the way for licensing centralized digital exchanges.
But DEX lovers are still plugging away, trying to build technology that makes these exchanges perform at the same level as centralized ones – which means speed, scalability, performance, and trust. And they’re doing so in order to tie up with centralized exchanges, as lines between business models blur.
One such software developer is OAX, a foundation in Hong Kong that was the originally conceived by the senior executive team at what is now BC Group, who got their start by launching a retail digital-asset exchange, ANX.
OAX has shifted from creating its own DEX to developing the software for decentralized trading. It launched a prototype in 2018 with the assistance of developer Enuma Technologies to try to scale on top of the Ethereum protocol – what techies refer to as a “layer-2 solution”, with Ethereum’s blockchain, which mines and confirms transactions, as layer-1.
Its new solution is called L2X, which uses smart contracts and off-chain transactions (i.e., those executed off the main Ethereum blockchain) to get around Ethereum’s essential slow pace. This has allowed OAX and Enuma to run at a speed of 1,000 transactions per second, which is faster than Ethereum by a factor of almost 100 times.
Existential equations with Ethereum
But that’s still nowhere near as fast as big centralized exchanges such as Binance and Huobi. Moreover, the Ethereum protocol is itself a problem. Ethereum trades tokens, one of which, called ERC-20, has emerged as the protocol’s emerging standard for designing smart contracts.
The benefit of working with ERC-20 standards is that there’s a huge number of developers worldwide tackling common issues, so there’s a lot of open-source learning and sharing. But Ethereum itself is slow and clunky. The Ethereum community is working on “Ethereum 2.0”, a reinvention of the protocol to address problems with speed and scale. Hopes for a quick resolution have given way to the realization that “Ethereum 2.0” is at least two years away.
Chan says, however, that this is not a deal-killer for companies like OAX and many others developing businesses with ERC-20 smart contracts – hence projects like L2X, which are meant to be nimble workarounds.
From tech specs to trust
L2X was released to an open-source testnet in 2019 to enable Etherem developers to play with it. But, says Wayland Chan, OAX’s technology leader, this lead to a new challenge: trust.
“Self-custody is now solved,” he said of the technology. “But trusting that an exchange can execute faithfully and manage your balances?”
This cuts to the meaning of a DEX. Proponents of these P2P marketplaces say they will empower sponsors and investors, and remove the counterparty risk of relying on a centralized exchange. Self-custody means users take responsibility for the security of their assets, cutting out third parties (which in cryptoland have so far often been easy to hack, or bad at countering inside dealing). Part of the L2X operating model is to provide dispute resolution to users, as a means of addressing the trust issue.
“We’re used to centralized exchanges doing things for us,” Chan said. “People want the convenience of a centralized exchange without regard to the safety of their funds.”
Amanda Liu, general manager at OAX, says the organization does not share the view of the libertarian-anarchist faction that likes DEX because it can mean no KYC or other identity checks. “Our position embraces regulation,” she said.
OAX is working with Blockpass, a blockchain developer, for solutions regarding identity management. It’s part of the ethos in the DEX world that technology can provide a better way to manage operations, and OAX sees it as an improvement on the status quo.
“We’re not tearing down the establishment,” Chan said, “but using technology to do things more efficiently and avoid rent-seekers.”
Indeed, OAX now sees its business model as partnering with centralized exchanges. Chan says many of them, including Binance and Huobi, operate DEXs on the side, to attract the investors who want to avoid being identified.
“We’re in discussion with exchanges who want a decentralized solution, either to have a DEX alongside, or to replace their existing, slow DEXs,” Chan said, declining to name them.
Pairing with a centralized exchange would also give a DEX an instant feed to liquidity, which DEXs have failed to attract on their own.
BC Group , meanwhile, is gunning for a Type 7 exchange license from the Hong Kong Securities and Futures Commission. Will a side-DEX play a role in that bid? OAX won’t comment.
The license has the same KYC and other reporting requirements as a traditional stock exchange. This suggests to DigFin that DEX models will remain peripheral to the institutionalization of the digital-asset space, as it’s hard to square their P2P nature with a regulator’s requirements – but might have a growing role among vendors looking to remain unregulated. Stay tuned.