Why are decentralized exchanges (DEXs) necessary for the space

I’ve spent several months studying various financial crashes and recessions and they almost always include powerful, trusted third parties (e.g. banks) that can’t pay back their users after certain events occured. Take the Lehman Brothers bankruptcy during the 2008 crisis as an example. They had a leverage between 30-60:1, meaning they only held 1$ for every 30-60$ users gave them. This is all fine when things are going smoothly, but the moment shit hits the fan and people want to take out their money, there is a problem. Indeed, when risky house loans started to bail (Lehman brothers invested a significant amount is shitty, high interest loans), people started getting scared and wanted their money out of the market. Unfortunately, Lehman didn’t have enough money to allow all their users to sell their stocks, in fact only 1/60 of the money, which was catastrophic when users rushed in to cash-out. Long story short, people couldn’t take out their money because the third party they trusted where selfish a greedy. Sounds familiar?

Back to the crypto world. Yes, many people are aware that exchanges a central point of attacks and billions of dollars have been stolen from users via crypto exchange hacks (see Mt. Gox as an example). However, this is not the only concern users should have. Not only you you need to trust centralized exchanges are competent enough to protect their funds, you also need to trust that they will not steal your money and that they keep enough funds to repay all their users. The latter point is often dismissed, but I believe this is what will trigger the real crypto market crash, like so many financial crisis in the passt ;

Imagine a big correction due to some regulations. Fine, the market loses 30-60%, nothing too crazy for us, but this time people try to cash out from Coinbase and Coinbase runs out of money and crypto. Users over Coinbase can’t withdraw their crypto nor fiat since Coinbase didn’t keep in reserve 100% of their user funds (maybe they where lending crypto, or investing their cash, who knows). Well, if that happens, users on other exchanges will start thinking that maybe the exchange they are using don’t keep all their users funds ... and they should take their own crypto and fiat out as fast a possible before the funds are depleted. This creates a chain reaction where everyone tries to take out their finances from centralized exchanges and these centralized exchanges go bankrupt, leaving a lot of people without anything. Sounds familiar? This is pretty much what happened in 1929 during the great depression, but with banks instead of exchanges.

Now, this is of course speculation, but history showed us many times that centralized parties can’t be trusted with too much of the population's funds, because if they fail to protect their users, we all lose (except them, of course, thanks to gouvernement bailout).

Enters decentralized exchanges, where users never give control of their funds to a central party, meaning all the funds are always 100% in the hands of the users. In consequence, the central party can’t steal their users funds, they can’t allow their users funds to be stolen by a hacker and they can’t have a crazy leverage like the Lehman Brothers since they never hold users funds! You don't need to rush it to withdraw your money if you never deposit it in the first place. To me it always baffled me why the decentralized world of crypto embraces centralized exchanges so much. This is a recipe for a disaster, especially since crytpo exchanges are poorly regulated, increasing the chance of greedy behaviors that could create a market crisis.

0x Project : Overview

Overview : The Technology

The 0x project is a decentralized exchange protocol on the Ethereum blockchain. This means that 0x is not an exchange per say, but a set of tools facilitating the creation of decentralized exchanges, or DEXs. The project consists of a set of smart-contracts and librairies that are completely open-source and accessible to use. The smart contracts ensure that the tokens are swapped atomically, i.e. in an all or nothing fashion. The tokens are only exchanged if both sides of the exchange have their funds transferred. One cool thing is that this atomic swap happens without having to deposit any funds, directly from your wallet. This is possible thanks to a set of functions part of the ERC-20 token standard, the most common type of token on Ethereum. Effectively, you give permission to the 0x smart contract to trade on your behalf and simply need to sign a message (totally off-chain) when you want to create an order. This means that, just like on Etherdelta, creating an order is totally free, no transactions involved and you always keep your funds in your own personal Ethereum wallet, increasing user control and security. You don't need to fear that this permission is dangerous since the smart contract is controlled by no-one.

The 0x DEX structure is said to be on-chain settlement, off-chain orderbook, meaning that all the orders created need to be hosted by a 3rd party, just like with Etherdelta. This has the advantage that the only on-chain transactions happen when a second party (a taker) fills an order (e.g. by clicking on it on the orderbook), reducing by more than half the number of transactions necessary over the 0x protocol. This is great because it saves users money, but also because it makes it less heavy for the Ethereum blockchain (which is taking some hits since the last few months). Now, one cool feature of 0x regarding their structure is that exchanges using 0x can share their orderbooks if they want to, making it much easier for smaller exchanges to bootstrap their liquidity. Imagine someone wants to create an exchange, let's call it Tirex, to compete with Binance, but starts with 0 users. Of course, most people would not try Tirex since their is no liquidity and without users, there will be no liquidity. How do you solve this problem? Well, what if Tirex could take the orders from Binance and post them on their website? Users would go on Tirex and see that there are millions of dollar worth of orders for all the pairs they are interested in, giving them a reason to stay. Now imagine if you have 10,20,100 different exchanges sharing their orderbooks. This is an entirely new beast in the space and could dramatically increase competition among exchanges. Of course, not all these 100 exchanges will be successful, but the fact that so many are being created will increase the chance of seeing an incredible DEX coming to life (who would want to stick with Etherdelta forever?) that can compete with centralized exchanges.

Now, if the shared orderbook didn’t give you shivers, here’s another one ; dApps will be able to convert any token to any tokens in the background using 0x, without their users ever noticing. Ever thought it was crazy that one would need to hold 100 different tokens to be able to use the 100 different dApps you are interested in? Well, these dApps could directly convert your ETH or whatever you are using to their native tokens right when you use the app. Imagine you want to play some casinon on a Funfair casino, but you don’t want to buy FUN tokens. Well, if Funfair used the 0x protocol for their dApp, you could bet with ETH and your ETH would be converted to FUN at current market price without you ever noticing. This means that users could only hold ETH and be able to interact with any dapps, even if they require the use of 10 different tokens. In a tokenized world, this is what made me fall in love with 0x. This specific feature is called token abstraction, since you abstract tokens from the users and they can forget about what tokens they need to use.

Another interesting aspect of the 0x protocol is that it's very flexible. Indeed, exchanges built on 0x can look and behave very differently. For instance, some could look identical to Binance or GDAX, while others would be similar to shapeshift. The efficiency and trading fee structure can also be very different, creating an amazing competing market for the cheapest and most efficient exchange to use.

Overview : Development

Another reason why I like the 0x project is because they built a protocol instead of an app. In my opinion, protocols are much more interesting than standalone app since you open the door to other teams to unleash their creativity and talent while using your product. 0x was released on the mainnet in August 2017, a few days before the team launched their ICO. Yes, you heard it right, the project was usable and completed before the funds were raised. Perhaps this says more about the quality of most teams in the space, but to me this was mindblowing considering how many products are still in research and development long after raising public funds. Even more incredible is that there are already 12 exchanges being built using the 0x protocol, some which have very talented teams and were able to raise their own funding. Not only 0x allows the creation of decentralized exchanges, but other projects can use the 0x tools to allow some exchange functionability, like dy/dx. Here’s a list of all the teams and projects building a 0x based exchange or planning on using it for their dapps. It’s also interesting to note that Radar Relay, the first 0x exchange on the mainnet, currently has a volume of 10 million USD. Imagine when you have 20 different 0x DEXs live, all better than one another ; the volume is going to be incredible.

Overview : Incoming milestones

Currently, 0x only supports the exchange between ERC-20 tokens, but wants to soon expand to other types of tokens (like ERC-721). In addition, they have a bunch of cool improvement that should make the 0x protocol more efficient and flexible, which should go live in Q2 this year. Now, I know that some are concerned that 0x is only for Ethereum tokens. First of all, it’s important to note that the Ethereum ecosystem is worth above USD 150 billion if you combine the market cap of all Ethereum based tokens and Ether itself. This is not a trivial amount and can generate substantial profit for Decentralized exchanges that exclusively focus on the Ethereum ecosystem. Now, of course there is more than just Ethereum and cross-chain atomic swaps would be awesome. Fortunately for 0x, cross-chain platforms such as Polkadot, Ark, Aeon, Cosmo are working very hard to allow blockchains to communicate with each others. Once this happens, all the coins on various chains will be pegged 1:1 with a corresponding Ethereum token, allowing you to trade them over Ethereum and 0x. This is the bet the 0x team is making and I think it’s a good one. Cross-chain bridging platforms will come, otherwise the entire blockchain space is doomed. Imagine the Internet only consisting of a bunch of intra-nets not talking to one another ... the inter-net wouldn’t exist. It’s the same for blockchain. Intra-blockchain stuff is cool, but allowing inter-blockchain communication is a totally different world and needs to happen. The 0x team is therefore focusing on building the best decentralized exchange protocol while other teams are solving the cross-chain bridge problem and soon these two pieces of technology will go hand in hand. At that moment, 0x could be used to exchange almost all coins in existence.

0x Competitors

0x has many competitors and I will go briefly over how they differ from 0x.

Kyber allows anyone to become a reserve manager and liquidity provider. Traders using Kyber can buy and sell at current market price, a price that is regulated by the reserve managers. This is a special case of decentralized exchange and I think can certainly cohabit 0x. Think of your favorite exchange. Is there a single price you see, like shapeshift? That’s what Kyber is building. Is there an orderbook with a bunch of various orders that you can click on, like Binance? That’s what 0x is building. However, this difference is not 100% accurate, since 0x can also achieve what Kyber is building via the Reserve Manager strategy. Kyber protocol is also not completed yet and can’t be used at the moment. Nevertheless, I still think kyber and 0x can coexist since they have their own speciality.

Airswap only focuses on “Over The Counter” (OTC) trades, where 2 parties discuss a price and then shake hands to make the deal. Perhaps this bargaining could be automated, but in general this seems like something 95% of traders would hate. However, Airswap might be useful for very large coin holders such as exchanges that want to cut deals among each others without affecting the market price. Airswap is very different than both 0x and Kyber and I don’t see it as a competitor to either since the use case is not the same.

IDEX is a single decentralized exchange (not a protocol like Kyber or 0x) that uses virtual settlement, meaning that it can update their users balances almost in real-time without risks of having two users taking the same order at the same time, just like a centralized exchange. One major problem is that virtual settlement is not a real state-channel and every single trade needs to be settled on the blockchain eventually. Hence, the moment the number of trade over IDEX exceeds the throughput of Ethereum, you have an orderbook that will grow way ahead of the chain. Trades might therefore need to be settled very far down the line, preventing you from withdrawing funds for a long period of time. It would be great if instead of using virtual settlement they used real state-channels however.

Why I believe ZRX is a good investment

First of all, since exchange fees have to be paid in ZRX, it’s obvious that the more the 0x protocol is being used, the more ZRX will have a high velocity. Yes, users might not need to hold ZRX to use an 0x based exchange (thanks to token-abstraction, explained above), but ZRX still needs to be passed around. Hence, the higher the volume over 0x, the more people will need to hold ZRX (be it market makers or the DEX themselves), the higher the value should be.

The second use of the ZRX token is governance, allowing users to vote on changes to the protocol (in the future). I see this similarly to stocks with voting powers, but without dividends. It would be great if holding ZRX meant you would receive some dividends, but this does not mean ZRX will not be valuable. Indeed, take Amazon and Tesla as examples. Amazon has a market cap of 600 billion USD and Tesla a market cap of 55 Billion, but neither stocks pay any dividend. Hence, the only thing these stocks give the stakeholders is a voting power, similar to what the ZRX offers with it’s governance access. This is impressive since Amazon is among the 5 biggest marketcap in the entire world , but the stock only offers voting power. To me, this is confirmation that a governance token can become extremely valuable even if it doesn’t pay dividends to the holders.

Considering exchanges are the most lucrative business in the crypto space at the moment (with mediocre exchanges like cryptopia making a daily income of above a million dollar) it is obvious that successful exchange protocols will make it big. The more money is poored in this space, the more volume there will be on exchanges. If DEXs are the future of exchanges, I’m willing to put my money on it.

Combined, I think these are three good recent why ZRX is a good short-term and long term investment. Short-term because 0x based exchanges are coming fast and the long-term potential should be obvious.

There is so much more to talk about, but I think that’s enough for this month. Feedbacks are welcomed!

0x Project (ZRX token) In Depth Overview