Decentralized Exchanges. Part I.
Opportunities for investors or regulation nightmare?
We’ve already talked about how DeFi is one of the key components of the Web3 ecosystem because “internet money” is a default use case in the original Bitcoin paper. Now let’s dive a bit deeper. With much lower entry barriers came all kinds of digital assets (also covered in Token vs Coin note!).
The amount of hustle required to mint your own token is still significant (difficulty level may vary from “push that button and pay a fee” to “spend years of research to set up your own token economy and the infrastructure required to support it”). Yet it’s still much simpler than printing your own money, which is also illegal but we’ll get back to that later.
Right now the question is “what can be done with all those tokens?”. Suppose you’ve got some Ethereum, USDTs (TRС20), and some mystery project tokens you got from an airdrop. It’s no fun just to leave them sitting there, so you’d like to:
- Turn TRC20 stablecoins into ERC20 (which means moving them from the Tron blockchain to the Ethereum chain);
- Sell a fraction of Ethereum for fiat (issued by a state’s central bank) and keep the rest until the price moves at least 1,5x;
- Exchange mystery project tokens for some other token, because you believe it will be the next big thing.
Each of these tasks might require a different type of solution, yet all of them revolve around exchanges and underlying concepts. Any exchange works with two basic ideas:
- a list of who’s willing to sell which asset, how much and at what price (might be a spread between x and y), and who’s willing to buy called an order book;
- a way to match those requests (orders) if not instantly but in a reasonable time, in other words, a way to provide liquidity for the traded assets.
Exchanges taxonomy is based on how each approaches and solves these two problems: constantly monitoring new and existing orders and providing liquidity to satisfy them. The next level of complexity comes with what else you can do with your assets. For example, which derivatives the exchange supports (options, futures, their combinations). Other things like being able to operate with tokens on different blockchains are a technological particularity (if not limitation) that comes with the way how things work in Web3, rather than a feature.
Back to our to-do list. Striking out number one is simple: just find the exchange that works with the particular pair of tokens you’d like to swap (the reason they are also called swaps). Good examples would be Uniswap or growing in popularity Via Protocol — these types of tools got simple interfaces, nothing extra, and work with the most popular wallets and chains. Order Books are monitored by automated contracts, liquidity comes from crowdsourced pools.
Since everything is a token (or could be tokenized) in Web3, task number three could also be reduced to swapping one token for another using a swap protocol. Web3 magic at work!
The second step could be done in multiple ways, at least the selling ETH for fiat part. You can find a peer-to-peer marketplace and place an order there (but it could take time before you find someone willing to buy the exact amount of ETH you’re selling at the price). You can go to a centralised crypto exchange — the key difference from your perspective is that it would take your funds in custody, meaning you’d have to pass a KYC procedure and your funds would be moved from your wallet to the exchange. Sell your ETH there for USD and then withdraw the funds to your traditional bank account.
In both cases, the problem occurs: you have to comply with the regulations regarding crypto, which may drastically vary depending on the jurisdiction you’re in. Hence, the nightmare part. There’s no problem until fiat money is involved. Once you’re moving money from one person to another — you have to explain these movements, and crypto right now is in the grey zone. Right now there’s no standard approach to how “internet money” should be treated. With all the potential that is out there (and funding), it is unwise to just ban everything Web3-related. Some regulations might actually be good and aim to protect peoples rights and financial wellbeing. So it is up to you to figure out the risks — let us know if we should write a “Web3 legal guide” next!
As for now, there’s no way to “cash out” ETH for fiat in a decentralized way, while decentralized exchanges that operate with crypto are certainly a thing.
From the technological perspective, centralized and decentralized exchanges could be susceptible to various security breaches, depending on where and how they execute their business logic. Keeping operations financial data safe when it’s being processed is one of the priorities, which makes a great use case for Super Protocol — read more in our whitepaper!
Written by Artemy Domozhakov-Liarskii especially for Super Protocol