Cryptocurrencies are beginning to permeate the traditional financial system, shining a spotlight on the mechanisms used to convert these crypto-assets. While Bitcoin, Ethereum and other ‘blue-chip’ decentralized cryptocurrencies have proven that decentralization adds to the resilience of a network, custodial platforms for cryptocurrency conversions have reintroduced the concept of a ‘trusted third party’ into a cryptocurrency market looking to achieve trustlessness. As the volume and variety of cryptoassets circulating in the markets continue to expand, decentralized applications for token conversion will become crucial to facilitating liquidity and accelerating adoption.

DEXs: Winning on security and control, losing on UX

Decentralized cryptocurrency platforms allow users to retain control of their funds throughout the token conversion process. Many utilize a hybrid architecture consisting of off-chain orderbooks with on-chain settlement, allowing users to keep their keys throughout the order-matching process which occurs on a centralized server.

Current user interface of IDEX

Aside from not being truly decentralized, these platforms suffer from a unique chicken-and-egg problem. Users gravitate towards platforms with sufficient liquidity, but it’s those very users who bring the liquidity in the first place. The dearth of liquidity has resulted in a poor user experience, which has significantly depressed the adoption rates of decentralized crypto conversion platforms.

Liquid and Loving it

Peer-to-peer platforms such as those based on the 0x protocol rely on Relayers to facilitate transactions. These Relayer platforms such as host and maintain order books and using the 0x architecture they can pool their liquidity together creating a more robust conversion infrastructure. After submitting an order to the Relayer, a market maker waits for a taker to fill that order, at which point the token conversion is trustlessly executed on the blockchain.

Bancor turns the exchange model on its head by letting users convert tokens against a smart contract-managed reserve instead of having to find a counter-party. Instead of requiring a counterparty for conversions, users on Bancor can convert between tokens against a smart contract. The interaction with the smart contract and all of the token conversions occur on a backend, requiring no technical expertise on behalf of the end user. All that the user sees is a simple interface, and the token conversion is initiated in a single action with the click of a button.

Current user interface of Bancor

A Bancor smart token contains reserves of both the converted token and BNT, Bancor’s native utility token. Users can frictionlessly convert between a given token and BNT. That BNT can, in turn, be converted into any other token making it function as a ‘connector’ on Bancor’s liquidity network. By removing order books entirely, Bancor is solving the liquidity dilemma facing hybird crypto platforms today.

Other benefits of this Peer-to-Machine model over P2P platforms include:

Fixed price slippage

The difference between the expected price of a conversion and the price at which it was actually executed, known as slippage, is largely dependent conversion and on the liquidity available to that particular platform. Low liquidity levels on hybrid-decentralized platforms mean that users are subjected to significant variations in slippage costs. Bancor’s algorithmic pricing ensures fixed slippage costs which can be calculated in advance.

Increased transparency

Converting tokens against a smart contract which operates according to a public algorithm allows the Bancor protocol to keep more information on-chain. Unlike hybrid DEXs, Bancor does not rely on centralized matching engines to facilitate token conversions.

Hybrid DEXs present a decentralized alternative for users wanting more control of their funds. However, the current design employed by many decentralized platforms is hampering liquidity and user experience. Bancor’s unique solution renders order books redundant by allowing users to convert tokens against a smart contract, overcoming the liquidity hurdle to mass adoption. Moreover, by enabling both algorithmic pricing and settlement that is fully on-chain, such smart contracts provide a more transparent and instantaneous user experience.

Written by @DAzaraf