What is decentralization?
Let’s talk about what
decentralization is and why this tech has mesmerized millions of people around
the globe? Why is decentralization loved by so many people and hated by so many
bureaucrats?
Decentralization is a process
of distributing the power among all the participants of a system, without a
central governing body. Today, the majority of traditional financial and state
systems are centralized, and this approach is plagued with flaws. The main
issue is that they have single points of failure: a security breach or a
central server/facility malfunction negatively affects the rest of the system.
Originally, cryptocurrency
was developed as a decentralized network that has no single point of failure,
which makes it democratic, more stable and efficient compared with regular
(paper) money.
The technology behind
decentralization in Bitcoin and most other cryptocurrencies is called
blockchain, and it gives every user the ability to serve as a node that checks
the validity of transactions.
What do users get from decentralization?
Here are a few key advantages
that users get from decentralized systems:
·
No need to trust a central authority that might be incompetent,
vulnerable to attacks, or even have ill intentions.
·
Less censorship. Governments often restrict their citizens’ access to
various websites and social media. Censoring traffic in a peer-to-peer network
is much more difficult, because every package can be sent to every other node
on the network, and they will relay this data further.
·
Most of the applications on the network are open source. Anyone can copy
some or all of the code, and create their own applications with it.
·
Proper economic incentives. Users who support the network get rewarded
for it financially. The more support they provide, the more they are rewarded.
Of course, decentralized
networks have their downsides too: they are usually slower to develop, have
lower adoption rate, might be more expensive or have lower efficiency at the
time of launch. However, most users agree that the end result is worth the
effort.
Here at Trade Fighter we
believe that the future belongs to decentralized technologies. We want our
users to be informed about such topics as blockchain, smart contracts and
decentralization, and with this post we begin a series of publications that
will help you not only understand these concepts, but also see the reason why
we use these technologies!
What
is Decentralization?
Written by Wayland Chan,
Technology Director, OAX Foundation
The term “decentralization” raises the ire of many
cryptocurrency enthusiasts.
Blockchain projects that
aren’t fully decentralized are treated with contempt by the purist crowd. Yet
the term itself is so generic and wide spanning that not many within our
community are able to even define what it actually means.
We at the OAX Foundation recently announced
a huge milestone in the testnet release of
our DEX platform, which was developed in partnership with Enuma Technologies. I’m writing this article
because the journey we’ve taken in reaching this milestone has been littered
with hurdles. Many obstacles we faced required technical decisions. With every
decision we made, it shaped the way our product evolved. And in that evolution
of our DEX, we always challenged ourselves with the simple question: “Is it
decentralized?” Answering that begs the question of: “What does it mean to be
decentralized?”
I’ve always posited that decentralization can come in many shapes and sizes. For the purpose of this article, we’ll only look at decentralization as it pertains to exchange platforms.
Decentralized custody of
assets
The biggest argument
for decentralized
exchanges (DEX) is not requiring users to trust exchange
operators to custodize the users’ assets.
The majority of crypto exchanges run on a centralized
model (CEX) in which users send their funds to the
exchange to hold in custody, so the user can trade on their platform. This
centralized location for the custody of such large amounts
of digital assets has always created a tempting target for attacks. The cry for
DEXs comes from the repeated hacks against exchanges in which users have lost
in excess of $1 billion.
DEXs have sprung up by
allowing users to keep their funds within their own private wallets but still enable them
to trade via their platforms.
Decentralized order
matching
Order matching is when an exchange
finds a buyer/seller willing to complete your order. Traders have an
expectation that exchanges will fill their orders with the best price, quickly and in a fair
manner (first come, first served). With centralized exchanges, we have no
guarantee that this actually happens.
Here’s an example of
what could happen on a CEX:
Let’s assume the price of
Bitcoin was trading at $3,600 USD. Jerry wants to buy 10 BTC at $3,600 USD.
Newman wishes to sell 10 BTC at $3,500 USD (wants a quick sale). Ideally,
Jerry’s buy order would be filled at Newman’s price of $3,500 USD. But there’s a
non-zero chance that a greedy exchange decides to buy Newman’s 10 BTC at $3,500
USD then turns around and sells them to Jerry at $3,600 USD each, thus
profiting $1,000 USD. If this happened, Jerry and Newman would be none the
wiser.
Decentralized
order matching provides full transparency of the order book,
allowing all participants an equal chance of filling orders. That transparency
enables true peer-to-peer (P2P) trading.
In the summer of 2018, OAX released a prototype DEX that had such a
decentralized order book. The sharing (or
broadcasting) of orders was done using Ethereum’s Whisper protocol. As a
Proof-of-Concept (PoC), this was a great achievement towards
“decentralization”. However, we quickly discovered that Whisper was unsuitable
for a trading platform due to its high latency. We also debated the privacy issues of a fully open order
book such as the one we prototyped. It was at this point that we decided to
re-prioritize our goals. Rather than coming up with a faster and decentralized
way of broadcasting orders (for the sake of openness), we decided that faster
settlement was more important at this stage.
Decentralized settlement
Settlement is the delivery of
assets upon payment. When does settlement happen in a CEX? It depends. Your
trade might have executed and your exchange wallet will show an updated balance
but that information is only within the realm of the CEX. The transfer of
ownership as recorded on the actual blockchain doesn’t occur until you withdraw
your assets from the CEX. So, on the surface, it may seem that your trade was
settled because you’re able to turn around and trade them from your exchange
wallet. The truth is, until you successfully withdraw from the CEX, those coins
aren’t truly yours as there’s no record of it on the blockchain.
DEXs can provide
decentralized settlement by enabling P2P trading where both sides of a trade is
settled (written to each respective blockchain) immediately via an atomic swap.
OAX’s DEX implements
decentralized settlement in a different way. Our Layer 2 (L2) solution has the
concept of a hub which maintains a network of state channels, enabling multiple
parties to transact with one another. Each transaction is authorized by signed
messages. Until the user decides to withdraw their assets from the hub, the
final state isn’t truly written to the blockchain (Layer 1).
This sounds eerily familiar
to what I just described for CEX settlement, doesn’t it? It is, but there’s a
very big difference: with our DEX, the user is in full control. Each
transaction results in a signed message that the user is able
to present as proof in the event of a dispute (we’ll cover our revolutionary
dispute resolution process in an upcoming article).
With a CEX, imagine if the
CEX had a data outage and lost all record of the trades you made? You would have
no recourse to recover all the trades you’d performed. In our L2 model, having
signed messages as proof of each trade removes that operational risk. With
OAX’s DEX, the user is able to withdraw at their choosing, without the need to
wait for approval from an exchange. Although the final settlement isn’t
immediate, it’s still guaranteed and fully within the user’s control. The
delayed settlement is a characteristic of all off-chain Layer 2 solutions and
is what enables us to perform significantly more transactions per second than
Ethereum.
These three areas of Custody,
Order Matching, and Settlement are only scratching the surface of what can be
“decentralized” in an exchange trading platform. It’s possible that in the
future, we will also be able to wave the magical “Wand of Decentralization”
over other elements of digital asset trading, such as token listings,
transaction monitoring, AML, KYC, etc. Maybe then, we could realize Vitalik’s vision of
a Decentralized
Autonomous Organization (DAO). But until then, if someone
tells you they’re decentralized, ask them exactly what they’re decentralizing.