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After centralized crypto exchange platforms, decentralized crypto exchange development is gaining significant traction. Decentralized exchanges generally refer to the use of distributed ledger protocols and applications. They enable crypto users to trade cryptocurrencies directly without requiring any third-party or centralized-party dependence.
Decentralized exchanges offer various potential advantages, including lower transaction fees, lower counterparty risk, and a range of crypto trading pairs with greater liquidity. Given the increased demand for these features, the digital world may witness decentralized crypto exchange adoption.
In this blog, you can explore the architectural structure and benefits, performance, and security advantages of decentralized crypto exchanges.
Decentralized Crypto Exchange | Architecture
Decentralized crypto exchanges describe both blockchain-based exchange protocols, as well as applications that use the protocols. Essentially, a decentralized exchange protocol refers to a software program that we host on or integrate into the distributed ledger(s). It facilitates automated peer-to-peer transactions on the distributed ledger.
Further, users get the ability to retain sole custody of their private keys throughout the transaction process and thus, ensure privacy. Additionally, users have access to readily available information. It is because a decentralized crypto exchange platform develops on top of a decentralized exchange protocol.
Also, it integrates with an on-chain and off-chain order book database and a GUI (Graphic User Interface), and APIs. Put simply, we can break a decentralized crypto exchange application into four components.
- Platform and technology implementation of a blockchain
- The mechanism of counterparty discovery
- The algorithm for order matching
- The protocol for transaction settlement protocol
A decentralized exchange application may not be completely decentralized in all four components. It is because, for various decentralized exchange applications, one or more components can be off-chain/centralized.
So, let’s discuss each of these components and explore how a decentralized exchange protocol implements these components.
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Platform and Technology Implementation
Generally, decentralized exchange protocols operate with tokens that feature the same technical implementation while being on the same distributed ledger platform.
For example, Stellar’s decentralized exchange is operable with tokens issued on the Stellar network. With Stellar decentralized exchange, users can also trade off-chain cryptocurrencies and assets.
A few decentralized exchanges also employ atomic swaps for the automatic trade of cryptocurrencies existing on different blockchain networks. Numerous decentralized exchange applications, however, focus only on token trading within one chain.
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Mechanisms for Counterparty Discovery
Mechanisms for counterparty discovery directly connect buyers with sellers who want to conduct transactions on mutually agreed terms. For instance, traditional cryptocurrency exchanges such as Binance require users to submit both market orders and limit orders. Further, protocols automatically match these orders with unidentified counterparties using an exchange’s central limit order book (an aggregator of all user orders.)
However, decentralized crypto exchanges also have order books. Order books may exist on-chain, hosted on a distributed ledger, or off-chain, hosted by third parties.
Essentially, instead of aggregating orders of all counterparties, a decentralized order book shows separate orders of each counterparty. So, a user needs to identify a particular order, and essentially, a particular counterparty, for initiating trading. In some cases, a decentralized exchange may not have order books.
Instead, it may feature a reserve-based model that enables the supply and demand of various tokens. These tokens are readily available for execution based on the reserve’s quoted buy and sell prices for that particular token.
These reserves are on-chain which requires smart contract solutions to enforce the execution and settlement of the trade. We can also automatically determine a trade’s price with a smart contract.
Also, Check: Secure and Efficient Crypto Exchange Development like Binance
Understanding On-chain Order Book
On-chain order books are directly hosted on the blockchain’s distributed ledger. After the submission of all orders to the distributed ledger, members of the network validate and process them. It enables anyone to host and access an order book’s copy.
Also, anyone can submit their orders to the order book if the distributed ledger is public. Instances of on-chain order books include Bitshares and Stellar decentralized exchanges. So, when two orders intersect in price, a decentralized platform automatically executes and settles the trade.
Benefits
Less censorable
No dependency on a centralized party for hosting and operating the order book. No centralized point of attack, compromise, or liability, and thus, a low risk of shutting down or restricting the order book.
Trustless Operations
Hosting an on-chain order book on a decentralized network means that one needs to trust centralized, off-chain actors. They will provide accurate and reliable publishing or broadcasting of the order books.
Also, Visit: Must-Have Order Types in a Crypto Exchange
Understanding Off-chain order books
Generally, a centralized authority hosts an off-chain order book outside of a distributed ledger. The centralized entity enables trading participants to match with other parties to make an offer on the asset. Also, it can restrict access to view or submit to the order book.
The use of on-chain and off-chain order books depends on the performance of the chain. A few decentralized exchanges face challenges with employing on-chain order books due to constant updates of orders to the blockchain.
The constant updating incurs transaction fees and wait time. However, the use of an efficient blockchain platform for a chain can ensure negligible transaction fees and reduced wait times.
Also, Read: Decentralized Crypto Exchange Platform Development
Matching Mechanisms
Matching mechanisms initiate the process of pairing buy orders with sell orders that have mutually acceptable terms. Decentralized exchanges provide automatic matching as well as manual identification and fill an order.
The use of computer algorithms pairs and executes buy and sell orders to enable automatic matching. Manual order filling requires a taker to manually identify a resting order on the order book, including actively executing actions for that particular order.
It is critical to analyze a decentralized exchange’s order-matching algorithm. It affects its ease of use, provision for fair exchange rates, and the latency of order fulfillment (wait time between order creation and order fulfillment).
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Transaction Settlement
Mostly, decentralized crypto exchange development feature on-chain transaction settlements. It is a critical element that eliminates the dependence on a centralized party (such as a centralized exchange). The on-chain settlement ensures that users can publicly validate their trade settlements on the ledger according to their desired terms.
A decentralized exchange performance is limited due to latency involved in the secure transaction confirmation on the underlying DLT (distributed ledger technology) like blockchain. It makes the speed of transaction confirmation on a distributed ledger network a bottleneck for decentralized exchanges.
However, at Oodles, we provide decentralized crypto exchange development services equipped with methodologies. We ensure the use of distributed ledger-based blockchain platforms that feature significantly higher latency than others.
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Decentralized Cryptocurrency Exchange Development | Essentials
Security
A decentralized crypto exchange’s security remains limited due to the underlying distributed ledger. Thus, it is important to ensure the ultimate security of a decentralized exchange by using an efficient blockchain like Stellar.
We must settle transactions with thoroughly audited smart contracts and distributed ledger platforms having a consistent functionality history to ensure security.
Liquidity
Generally, new cryptocurrencies are available for trading through decentralized exchanges. It is because it takes time for centralized exchanges to list new tokens due to regulatory risks. A user may only be able to attain and trade in various cryptocurrencies over decentralized exchanges.
Additionally, interoperability of a decentralized exchange’s protocols can enable pooling liquidity for “networked liquidity” with applications that use the same protocol. Interoperable protocols significantly spur greater networked liquidity.
Latency
The latency of confirmation times of a decentralized exchange depends on the underlying distributed ledger. We can facilitate the development of a distributed ledger network that permits significantly faster on-chain settlements with unique consensus mechanisms.
Suggested Read: Blockchain Consensus Algorithms
Conclusion
Centralized exchanges still face security and other challenges, including a delay in the listing of the latest cryptocurrencies. Here, users can adopt decentralized exchange development as an alternative for a more enhanced, secure, and efficient crypto trading experience.
Oodles is a blockchain development company that offers decentralized development in its offering. We have expertise in developing platforms that provide lower trade latency, higher liquidity, and intuitive user interfaces. Contact our crypto exchange developers to start with your project development.
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