🔥 The rise of Decentralized Exchanges, future innovations & path forward

HashTalk with Sankalp Issue #14

“Without reflection, we go blindly on our way, creating more unintended consequences, and failing to achieve anything useful.”

-Meg Wheatley


Hi, I’m Sankalp Shangari. I’m exploring latest trends & my learnings and experiences in Startup & VC world and how upcoming technologies are reshaping the world as we know it, especially Blockchain & AI.

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🔥 Future is not bleak! Enabling the rise of Decentralized Exchanges

NOT SO FUN FACT: Top 5 Bitcoin wallets control more than 20% of BTC’s circulating supply all belonging to centralized exchanges. What if they lose access to their private keys?

Answer, the users will lose their crypto assets, just like the users of QuadrigaCX who lost $140 million after the CEO died and the private keys to QuadrigaCX’s cold-wallet got lost forever. Upbit is the recent most casualty. We wont go into details of that here. Though many exchanges now require two or more private keys to approve the movement of funds, it is still centralized. To put it in perspective, last year exchanges got $800 million of crypto assets stolen.

Decentralized Exchanges have upped their game considerably in the last 12 months, more so recently with a lot of innovation around corresponding products (lending, derivatives, options etc) and liquidity solutions. But are we there yet? . What I love about a decentralized exchange is the fact that everyone is in control of their own funds which enables peer-to-peer trading reducing the risk of Single Point of Failure. Dramatically reducing the risk of theft from hacking of exchanges. Each one to its own. Don't be fooled though, many are not truly decentralized and at times there is nothing to back up the cause. 

Second aspect of a Decentralized exchange is transparency. Since all the orders in a Decentralized Exchange is matched and executed directly between peer-to-peer, it reduces the risk of fake trading volume while making the process more transparent. Though Decentralized Exchanges are a promising idea, they also have flaws. Since, decentralized exchanges put all of the transactions/wallet financials records public, it’s something that some users may not like owing to multiple news’ of data breaches, user behaviour tracking and identity theft.

So, what I feel is first, we need to have a modified version of a decentralized exchange with privacy at its heart to make it more safe for the users. Second, since decentralized exchanges are struggling with availability and liquidity, an instant swap functionality with atleast 70% of the cryptocurrencies will provide much more needed liquidity. If we are able to build a Decentralized Exchange along the same lines with a privacy strong blockchain such as ZCash at its boilerplate level, we will be able to view a promising future for Decentralized Exchanges. With which Vitalik Buterin also agrees:

“If I was doing anything seriously privacy-demanding, I’d probably go for Zcash first”.— Vitalik Buterin

Sure, the adoption to Decentralized Exchanges will increase but we do need to sort out these two pain points of users.

Advancements in Decentralized Exchanges

  • Cross Chain Swaps & Plasma: One of the biggest drawback of a decentralized exchange is having restriction on the number of trades that can be made. And surprisingly, almost all of the most promising DEXs and protocols about to be launched are looking to solve this problem. According to Hackernoon:

    “One more market ready solution to roll out faster DEXs is the Plasma Protocol wherein the performance of DEXs can be enhanced to match throughput of a centralised exchange, while simultaneously ensuring safety of assets by using a hierarchical state channel approach towards the rootchain, dApps & sidechains along with an extra implementation of zero knowledge proofs (L2 scaling)”

  • 0x Protocol for Ethereum DEXs: Much like rest of the world, we know that 0x protocol has many advantages over peer-to-peer exchange of ERC20 tokens. And the team at 0x also aims to resolve one more big issue with exchanges and that is of interoperability.

  • Eliminating Front-Running completely: Front-Running is one those issues that really pisses off traders to the brink. But, they cannot do anything about it. Many companies like AirSwap & ShapeShift are already claiming towards eradicating front-running but are unable to do so. The most obvious solution to this issue comes as concealing the “transaction” amount of the orders. But again, it failed since bad players in the trading system found a way to exploit it also. The next solution which is being touted as the better solution is K-Anonymity, in which superficial and virtual data points (transaction details in this case) are added with the data point that you want to conceal (the transaction details of an user in this case) such that it is nearly impossible for the bad actors to front-run that buy or sell order. While still managing to get it through with the smart contracts.

But, there’s a long way to go. For example, in the last 7 days, DEXs had 108 Million dollars in volume in comparison to centralized exchanges more than 80 Billion dollars 24-hour volume.

Some Charts for Decentralized Exchanges

  • Trade Distribution Among Different Ethereum Protocols: We can see IDEX takes a lead along with Uniswap, Bancor & Kyber though most of these services are not Decentralized as they don’t host order books. Also, DEX protocol like 0x are struggling to gain adoption.

  • Market Share: IDEX holds more than 50% market share. Various token swap services hold around 33% market share. Two different versions of 0x protocol hold only ~7.6% market share. Showcasing good demand for token swaps services like ShapeShift & Chengelly.

  • Top Tokens Traded on DEX (excluding ETH/WETH): Dai is the top-traded coin on DEXs. One more interesting fact is that around 15% of all trades on DEXs involves tokens which are not listed on any CEX, only on these DEXs. Note: Dai volume doesn’t indicate that Dai is getting used for trading, this data involves Eth2Dai.

The data above shows that even after 2 years and millions of dollars in funding, decentralized exchange protocols are still fighting to overtake CEXs and offer the same level of functionality, liquidity, and service. Decentralized Protocol projects such as 0x (ZRX) and Loopring (LRC) have been working hard. Decentralization is not the value proposition and projects already understand it. You can’t sell inefficient products in the name of idealist values, no one cares.


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Disclaimer: None of the content in this newsletter is meant to be financial advice. Please do your own due diligence before taking any action related to content within this article.

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