A novel form of trading – also known as decentralized trading – is fast becoming popular. Buyers and sellers are connected directly in this form of trading. 0x is a decentralized exchange for trading ERC 20 tokens. (See also: What Is ERC 20 And What Does It Mean For Ethereum?). It is among the most high-profile examples of decentralized cryptocurrency exchanges.
How is Ox different from a regular trading model?
Most cryptocurrency exchanges follow the established centralized trading model. In this paradigm, they are gatekeepers providing the infrastructure and acting as connecting agents to clear and facilitate trade between parties. North America’s largest cryptocurrency exchange, Coinbase, is the best example of this approach. This model requires customers to trust their funds with exchanges. While the model has worked for equity markets, an increasing number of hacks at exchanges has put its future in cryptocurrency markets under a cloud. Decentralized trading seeks to address that.
A Craigslist For Cryptocurrencies
0x is a decentralized exchange protocol that developers can use to build their own cryptocurrency exchanges. The company’s founder refers to his solution as the “Craigslist for cryptocurrencies” in that any developer can build their own cryptocurrency exchange and post it online.
In a decentralized exchange, smart contracts are the basis for the trading of ERC 20 tokens. The profusion of tokens and contract types presents a problem of confusion and scalability, however. Consider this statistic: there are 101834 token contracts on ethereum’s blockchain, as of this writing.
“End users are exposed to smart contracts of varying quality and security with unique configuration processes and learning curves, all of which implement the same functionality,” the whitepaper’s authors write. Specifically, this approach resulted in two problems for ethereum’s network. (See also: Will Bitfinex's New Decentralized Exchange Boost EOS Prices?)
First, it resulted in increased gas costs for developers. Gas is the amount of ether, ethereum’s cryptocurrency, required for each transaction. Within the context of cryptocurrency exchanges, this means that each buy or sell transaction would cost a specified number of gas tokens. Consequently, as the volume of orders increases on the exchange, the costs of operating the exchange also balloons. Second, the approach has fragmented users among numerous cryptocurrency exchanges. The distribution of users among these exchanges has resulted in a corresponding fragmentation of liquidity.
0x uses common smart contracts over a shared infrastructure. Its technology combines two strategies – State channels and Automated Market Marker (AMM) - that have already been suggested to overcome these problems. State channels take transactions offline, thereby reducing costs that are incurred if the transactions take place on ethereum’s network. AMMs introduce a third party to facilitate trades if the price of a cryptoasset reaches a certain threshold. Thus, AMM conducts trades between the two parties (instead of the parties conducted it between themselves) and also acts as a counterparty. 0x founders describe their system as an “off-chain order relay with on-chain settlement”. “Cryptographically-signed orders are broadcast off of the blockchain, an interested counterparty may inject one or more of these orders into a smart contract to execute trades relentlessly,” the whitepaper’s authors write. The protocol’s innovation lies in relayers, which are used to connect makers with takers.
Its token – ZRW – is used to pay fees for use of the relayers.
The Problems With 0x’s Approach
Critics have already begun pointing out significant flaws with 0x’s approach. For starters, they say that the role of its token ZRW is unclear. 0x maintains the token is used to pay relayer fees. But ether, ethereum’s native cryptocurrency, can also be used for the same purpose. In fact, ether delta, another crypto exchange, has already tried a similar approach using ether. The protocol’s founders have also not elaborated on their approach to governance in the whitepaper. If it involves staking, or holding given crypto(s), for an extended period of time, then 0x’s governance and trading could be hijacked by investors with significant holdings of cryptos.
There are also concerns that its business model might not be sustainable. As cryptocurrencies became popular last year, exchanges made money hand over fist by collecting fees to facilitate trades between buyers and sellers. For example, Coinbase booked revenues of $1 billion in 2017 while China-based Binance claims to have already made profits of $200 million this quarter. The main source of cash for both exchanges is fees from cryptocurrency trades. By allowing its protocol to remain open and free, 0x might be forgoing an important source of revenue and setting itself up for liquidity problems and failure. In an interview with Techcrunch, a developer described 0x as “the best analogy is trying to monetize Linux”. Linux is an open source operating system that can be downloaded for free.
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