How TXA Will Power Next-Gen Hybrid Centralized / Decentralized Exchanges (Part 1 of 2)
Let’s explore the challenges of centralized and decentralized exchanges which inspired the creation of TXA
Cryptocurrency traders must often choose between the speed, convenience, and liquidity of centralized cryptocurrency exchanges (CEXes) such as Coinbase and Binance, and the privacy, self-custody, and transparency of decentralized exchanges (DEXes) such as Uniswap and Sushiswap. Thankfully, this dilemma will soon be a thing of the past, as the TXA Decentralized Settlement Layer will soon enable the development of a new breed of exchanges that combine the best features of both CEXes and DEXes.
Continue reading below to learn about the problems facing crypto traders today which inspired the creation of TXA.
Problems With Centralized Exchanges
CEXes are built using the typical Web 2.0 stack of a username/password-based login system, centrally hosted database, and exchange-owned cryptocurrency wallet. Trades are recorded on the exchange owner’s database without the need for any blockchain transactions, and so are limited only by the speed of the database. This allows for practically instant trading of assets, and for seamless cross-chain asset trading. While those are certainly significant benefits, centralized exchanges also come with unique disadvantages:
CEX Disadvantage 1 — Counterparty Risk
In order to use a CEX, users must first send their crypto to an exchange-controlled wallet. Users must place total trust in the exchange operators to properly manage their assets. They must trust that operators are both honest and technically competent enough to avoid hacks. As the past decade has made clear, these are not theoretical risks, with millions of dollars worth of CEX users’ crypto lost by malicious behavior or security failures (or malicious behavior disguised as security failure).
CEX Disadvantage 2 — Lack of Transparency
Since all transactions on centralized exchanges occur only on the exchange’s own private databases and not on a public blockchain, it’s easy for operators to behave badly without being caught. Exchange operators may falsify trading volumes to manipulate the price of assets or front-run transactions in secret.
While DEXes have some similar issues, they are publicly known, extensively documented and tracked, and the community is working on ways to deal with them. When it comes to CEXes, there’s no way of knowing how widespread the practice may be or of preventing it.
CEX Disadvantage 3 — Lack of Privacy
As centralized exchanges are typically operated in the real world, they must comply with the laws of the jurisdictions where they operate. Typically they require users to share their real name and confirm their identity by providing identifying documents such as a driver’s license or passport, with more detailed requirements for users looking to trade or withdraw a larger amount of assets.
It would be one thing if this information never left the exchange’s files, however, it often does, either deliberately or by accident. Besides the leaking of KYC information in cases of security failures, exchanges can and are often compelled by various government bodies to share the identities and trading histories of their users. Unscrupulous exchanges may also sell user information to advertisers. For the privacy-conscious trader, none of these options are acceptable.
Problems With Decentralized Exchanges
DEX Disadvantage 1 — Low Speed and High Cost
In contrast with their centralized cousins, DEXes are slow and expensive to use. On Ethereum a transaction takes anywhere from 5 minutes to hours or longer, and can even fail if the trader didn’t pay a high enough transaction fee. Traders can increase transaction fees to speed up their transaction times, but this leads to bidding wars where some traders pay hundreds or even thousands of dollars for a single transaction. For many traders, it makes using an Ethereum DEX a losing proposition, while even for those who can afford the high fees, most would certainly be happy to have a cheaper option that retains the benefits of decentralization.
DEX Disadvantage 2 — Missing Cross-chain Interoperability
Decentralized cross-chain trading is still in its infancy. While solutions such as Thorchain offer a possible solution, their far from ready for prime time. The current most widespread solution relies on “wrapped” tokens, where a token is issued on one blockchain which represents an IOU for an asset on another blockchain. The most well-known example of this is WBTC, which is an ERC20 token issued on Ethereum to represent a 1 to 1 IOU for a BTC on Bitcoin. The issue with these solutions is they tend to rely either on a slow, complex, and expensive bridging mechanism for moving tokens between chains, or they rely on a trusted third party, which brings with it all the same issues mentioned in the above sections on CEX. Another issue is lack of choice, only major crypto assets with high volumes tend to be issued as wrapped tokens. Currently, for the vast majority of crypto traders, CEXes are the only practical way to trade between assets from different chains.
DEX Disadvantage 3 — Limited Order Types
While blockchains offer certain undeniable advantages, they also come with limitations. These limitations make it challenging if not impossible for DEX developers to offer their traders certain order types such as limit, stop, and trailing orders which are common on centralized exchanges. Uniswap, the most widely used DEX, offers only a single order type. While this is fine for some traders, having a variety of order types is essential for any serious trader in order to limit losses and protect their profits.
DEX Disadvantage 4 — Low Liquidity
After reading through the three problems mentioned, you’re probably not too surprised to hear that most pro-traders simply don’t use DEXes for most of their trades. The slow speeds, lack of control from limited order types, and lack of cross-chain trading mean that only CEXes currently meet their needs. The vast majority of crypto trading volume, therefore, occurs on centralized exchanges like Binance and Coinbase. As of today, the daily volume on the largest CEX, Binance, is approximately $25 billion, while on the largest DEX, Uniswap, it is approximately $2 billion. Low volume means low liquidity, and the problem is especially severe when trading less popular assets. Price spreads are often unacceptably large, greatly limiting the ability of those assets to be traded.
It should be clear to readers that neither category of exchanges discussed above is able to meet the needs of traders. The problems outlined in this article are what inspired the creation of TXA. In Part 2 of this article, we detail how the TXA Decentralized Settlement Layer allows for the creation of hybrid centralized/decentralized exchanges like Tacen’s hDEX which offers the best features from both types of exchange.
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The TXA Project is a revolutionary initiative to build a global decentralized settlement layer and liquidity pool that is compatible with any typically fast centralized exchange. We call this the TXA Decentralized Settlement Layer, which can be used by any exchange to handle its settlements in a P2P non-custodial manner. The result is a hybrid solution that combines fast centralized exchange order matching with a non-custodial decentralized settlement system, which we call the hybrid-DEX (hDEX).