Since the formal introduction of Ethereum in 2014, the network has exploded with products that allow users to transact directly with one another, without relying on a third party.
One of the most common use cases is that of a decentralized exchange (DEX), an idea that dates back to Vitalik Buterin’s unveiling of Ethereum in 2014. Examining the history of how DEXs have evolved can help elucidate where DEXs are headed and how they will compete with centralized exchanges.
What’s in a DEX?
DEXs come in a variety of forms, but share one common quality: non-custodial. DEXs use smart contracts to manage funds on-chain, so users never have to trust a third party with their money.
However, the exchange part of a DEX – the way buyers and sellers find each other – can vary widely from one implementation to another. When thinking about the future of DEXs, it’s helpful to first understand their past.
Alex Wearn is the co-founder and CEO of IDEX, a high-performance DEX. He has spent his career in software development, including time at Amazon, Adobe, and IBM. He has been hacking on crypto startups since 2014, transitioning to full time with the launch of IDEX in 2018.
The earliest Ethereum DEXs, like EtherEx and OasisDex, built a traditional central limit order book (CLOB) exchange entirely out of Ethereum smart contracts. Developers and users quickly discovered that order management and trade execution are not well suited for a blockchain. In particular, the placing and cancelling of orders by market makers, and the interaction of traders with the on-chain order book, were expensive and error prone due to the high costs and latency of on-chain transactions.
Off-chain order books
In mid-2016, a new exchange, EtherDelta, innovated on this model by bringing the order book off-chain. This design eliminated the cost of order creation and reduced the latency and gas costs of placing an order.
While it was a major improvement, users still incurred costs for canceling orders…