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How to make a Decentralized Cryptocurrency Exchange?

make a decentralized exchange

Cryptocurrency has come up big in a way nobody expected it to. Everybody and their dog is talking about bitcoin, ether, blockchain, DLTs and what not. There’s good reason to it, too. With the advancements in science and technology, the financial sector has also acknowledged that new and improved techniques can be used for the betterment of the industry. These methods include implementation of Blockchain, acceptance of cryptocurrency, decentralization of currency exchanges and what not.

Hold up, what?

make a Decentralized App

What is a Decentralized Exchange?

Some of you might have heard this term for the first time. For the veterans, they know all about it. Don’t worry, we’ll explain exactly what a decentralized exchange is, and why you should be looking into it. Currency exchanges are very easy to grasp and understand. You have a certain amount of currency X, but you wish to obtain currency Y for your leisure or work trip.

Simple, you head to a currency exchange, and get your currency X exchanged for Y as per the going rate. This exchange is the intermediary between two customers, two dealers. It helps people to get the desired currency in exchange for some unneeded currency that they may possess.

Now, cryptocurrency, as of now, is not accepted all over the globe as a mode of payment. Therefore, people, if they possess a certain amount of any cryptocurrency, must exchange it for fiat currency before spending it on their needs and wants. Some people may also be interested in earning money through trading cryptocurrency.

Enter Exchanges.

This is exactly where these exchanges come into play. They offer intermediate environments to customers to exchange, trade or act as middlemen to other transactions. This also provides an earning opportunity to people who are looking to delve into the world of crypto trading.

Up until now, centralized exchanges have ruled the roost. They are controlled and monitored by a central governing body, this may be an organization, a bank or even the government of a country if the exchange is run by them. They are easy to use and access, and provide features like margin trading. People are fully aware of them and hence look to exchange through centralized sources only.


There is one huge shortcoming of these exchanges, though.

They present a severe security problem, a security risk to your funds. Some exchanges might be more secure and tighter than others, but hacks and attacks are common in today’s tech-advanced world. Some exchanges are simply incompetent and incapable of lasting in the market and may use malicious activities like fractional reserve systems which may lead to bankruptcy or investor bailout.

The security issues with centralized exchanges were amplified by the Mt. Gox and the Bitfinex hacks.

More than 66 million USD worth of bitcoin was stolen from Bitfinex, one of the world’s largest digital currency exchanges. The vulnerability of multi-signature accounts and the way Bitfinex handles them was exploited to hack the system.

Community members took to social media to expose the news of their accounts being drained, and this hack had a direct impact on the price of Bitcoin, which tumbled to as low as USD 480 before recovering.

After the hack, Bitfinex remained offline, displaying a message to the users, which stated, “The era of commingling customer bitcoin and all of the associated security exposures is over.”Security is too major a problem to be ignored. Who would want to lose their potential lifetime earnings due to some silly hack on the exchange that they use? How to solve this glaring issue?

Replacing the custodian, intermediary and insecure centralized cryptocurrency exchange with decentralized echange application. But for this, we need to understand how these decentralized cryptocurrency exchange work.




Step in decentralized exchanges

A decentralized exchange is a market that is not controlled or presided over by any third party to hold consumer funds. Here, trading can be done directly between two customers through a peer to peer connection. This can be achieved by using proxy tokens, multi-signature systems and many other technologies currently in development. It is very important to know if you are looking forward to understand as to how crypto exchanges work.


Why and how to make a decentralized cryptocurrency exchange?            

They solve the most obvious problem with centralized ones- the problem of security and trust. Decentralized exchanges are basically trustless systems, as we are not required to have faith in a third party or the exchange itself to handle our funds. All finances are controlled by us in our own personal wallet.

These exchanges also offer a high degree of privacy, as users do not need to disclose any personal details to other traders, except, in some cases, to the person who is buying or selling from them. Anonymity, security and high hacking resistance are what makes these decentralized digital currency exchanges one of the more efficient methods to trade in crypto. Some of these currently in operation include Bisq and EtherDelta. Hope you have gotten a good idea as to how crypto exchanges work by now. Well, you need to stay patient if you’re looking forward to making a digital asset exchange software.

Wondering how to make a decentralized cryptocurrency exchange? Making an exchange is now as easy as you’d like! Read on.

Okay, so you have decided to build and operate your own cryptocurrency exchange.

Congratulations, by reading this article, you are on the right track already! Here, we cover all the steps required to set up and operate your own decentralized exchange in utmost detail. From the basics such as abiding by rules and regulations in the country of operation, to the most advanced APIs and app development work, we have it all covered.

So, let’s start with the basics. How to make a decentralized cryptocurrency exchange is how to build a business, essentially. With every business, there come some rules and norms of the industry that you are required to follow. Similarly, when you answer the question ‘How to make a decentralized cryptocurrency exchange’, you must follow a certain set of rules. Here we discuss this situation in more detail.


Problems in Decentralized Cryptocurrency Exchanges


How to make a decentralized cryptocurrency exchange: What features should it have?


How to make a decentralized cryptocurrency exchange


Decentralized cryptocurrency exchanges present to us a way of managing finances and trades which is unheard of. What makes them different from other options in this category are some distinct features that truly characterize decentralized exchanges.

There are some key features that you must incorporate when you focus on how to build a decentralized cryptocurrency exchange. From anonymity to security, from the control of funds to scalability, there exist some fundamental features that, simply put, have to be there in a decentralized exchange. After all, they make the exchange what it is.

Here we shed some light on these standout features one by one.

  1. Control of funds

Since decentralized exchanges have no governing body looking over the functioning of the exchanges, all funds and currency that moves over the network are controlled by the users themselves. The participants in the platform have complete control over their funds. Sure, there is more work involved in maintaining and updating your accounts on your own, but it makes you the true owner of your currency, which should be the case. Control of funds is probably the first thing you need to get right while making a digital asset exchange software.

  1. Security

Decentralized exchanges are less prone to attacks and hacks since they have no single point of entry. An attacker would need to infiltrate multiple nodes on the network simultaneously in order to even have a chance of compromising the network. Even if one or two nodes go down, the exchange keeps functioning as it is independent of any central server or node that controls the whole process. This leads to added security over the network and gives more power to the users or participants in the network. This was all you needed to know when it comes to the security of digital currency exchange.

  1. Anonymity

Decentralized exchanges are the distributed blockchain equivalent of centralized exchanges. They ensure privacy and anonymity for every user transacting on the network, as users are not required to provide their personal details to anyone, except if the trade involves bank transfers. Even in that case, the user’s identity is revealed only to the person buying or selling from that user. Thus participants can use decentralized exchanges in a carefree manner, knowing that their identity and their money is safe.

  1. Authentication

Due to the decentralized nature of these exchanges, there is no dependent on an intermediary or third party to authorize and authenticate transactions. For example, in the case of bitcoin, users on the network themselves authorize transactions and then relay authentication details to all nodes on the network. This also has the added incentive of generating currency for the authenticating user. By means of tactics such as smart contracts and blockchain protocols, trustless authentication and authorization of transactions are possible on decentralized cryptocurrency (Digital Currency Exchanges) exchanges.

  1. Scalability

Decentralized digital currency exchanges provide an infinite potential for scalability. The usability of these technologies may not be sky-high as of now, but it remains something to look out for in the near future. Especially in the fintech sector, the potential of decentralized exchanges remains a point to be kept in mind whenever innovation is brought up. As for the scalability part, expansion of a decentralized exchange is incredibly easy, again owing to its decentralized nature. That is exactly how crypto exchanges work, or are supposed to. Anybody can join the network and start trading on it, and thus be established as a node in the network.

  1. Easy integration with existing wallets

A major merit and a huge point to be considered when we think of how to build a decentralized cryptocurrency exchange, integration with hardware wallets remains a key advantage of decentralized exchanges. Users can transfer currency directly from their hardware wallets to any existing decentralized exchange. The need to manually enter private keys is also removed, as some services like MetaMask offer options for users to import private keys from existing networks in order to access funds through Metamask. This saves the user from keyloggers and other malicious software attacks.


How to make a decentralized cryptocurrency exchange

Thus, whenever you think about how to build a decentralized cryptocurrency exchange, you must look into adding all of the aforementioned features into your exchange. This, simply put, is a must for any exchanges out there, as they are what describes and characterizes a decentralized exchange. Security, integration, anonymity, and authentication are paramount when it comes to establishing your own exchange. So, get your facts right, and do things the right way.


Problems in Decentralized Cryptocurrency Exchanges


The architecture of how to make a decentralized cryptocurrency exchange.

Okay, so you have decided to build your own decentralized exchange. You’ve researched about all the legal permissions and regulations that you need to follow, and you’ve decided what cryptocurrencies to trade in. Now what? It’s time to get yourself familiarized with the architecture and system behind making an exchange channel. The advanced stuff, the technicalities, the front and backend stuff, and all the intermediary processes that are involved in making an exchange successful.

Without further ado, let’s get into it. The first step- concocting a contract logic for trading. Here, we start out on how to make a decentralized cryptocurrency exchange. If you are aware of the workings of Ethereum, you probably know what smart contracts are. Smart contracts are basically contracted terms between two customers written into the code of a database, for instance, blockchain. According to the coded terms, the contract executes itself whenever the executing condition is fulfilled.

Thus, on your exchange, you can formulate a similar smart contract logic which can generate cryptocurrency tokens on the same chain that you are working on. The only real flaw in this design is to design such a token using these contracts which can be connected to other currency exchanges, in order to trade using other currencies. This architecture can prove out to be detrimental for its use in point of sale solutions.

The Smart Contract.

Once a smart contract logic has been commissioned, there needs to be a validating procedure in place which verifies the integrity of the trades taking place. Taking the example of Bitcoin, it only allows up to 3 participants in multi-signature transactions, which is way less than a suitable number for the exchange to be considered legitimate. Considering the scale at which you want to build your digital asset exchange software, this part is very crucial.

We need some kind of signature verifications that can be done by a large number of participants, say about 50, out of which a majority needs to approve the trade in order for it to be considered legit.

We can do so by designing a threshold signature that is backward compatible with our native currency signatures, which will, in turn, install a notion of trust between the signing parties. This is because now, a method will be in place to accept one kind of currency in exchange for tokens of another currency, essentially the trade process which takes place in an exchange.

Here’s what you need to know about Off-Chain Order Books.

Off-chain OrderBooks are something that a number of people looking to make a decentralized Cryptocurrency exchange are trying to explore. To put their meaning in a simple manner, they are OrderBooks hosted by a centralized entity outside of the distributed ledger on which a DEX is operating. These entities help various parties at both ends to discover each other. Following this, once the offer for a particular asset has been made by someone, it restricts access to that particular order for being viewed or even submitted.

The way a decentralized exchange works, it is impractical as well as uneconomical to operate an on-chain orderbook since every new order or even adjustments to the old ones would need it to update in the blockchain, which means higher transaction charges along with cumbersome wait time. However, if the blockchain happens to be on with low transaction fees and negligible wait times, there is absolutely no problem with using an on-chain orderbook for moderate volumes.

That is the sole reason why the 4 decentralized exchanges based on Ethereum Blockchain – 0X, Airswap, Etherdelta and IDEX leverage only off-chain orderbooks since the gas costs associated with operating an on-chain orderbook on Ethereum blockchain is totally uneconomical. Not only this, the wait times on the order of minutes, too, is a problem. Now, let’s have a look at the 4 Ethereum Blockchain based Cryptocurrency exchanges and see how the off-chain orderbooks are implemented in each one of them.

0X Protocol – “Realyers” such as RADAR relay and many others are entities that host, manage, and publish off-chain orderbooks. The makers have to inform the details of their orders directly to the relayers irrespective of whether it’s a buy or sell order. The relayer is supposed to aggregate the orders they recieve into the orderbook. The takers then have to go through the orders that are present in the orderbook queries by the relayers. Following this, once the takers have found the suitable orders, they will have to fill the order by submitting information as per the smart contracts of 0x protocol based on the Ethereum blockchain.

Airswap Platform – The makers submit their “intent-to-trade” in any trading pair of their choice. They have to submit it to indexer. The indexer is then supposed to act as an aggregator for the makers and their intent-to-trade. The indexer is used as a counterparty discovery mechanism by takers in order to use discover the suitable makers as per the trading pair they are looking for. Upon finding the suitable maker, the negotiations will take place off-chain taking into consideration the fair pricing for the trade as per the on-chain distributed ledger.

Etherdelta Platform – The makers as well as takers have to deposit their tokens from the metamask wallet into the Etherdelta’s on-chain smart contract. As soon as the makers submit orders on the Etherdelta’s on-chain smart contract. Following this, the orderbook will ping the blockchain to verify whether or not the maker even has sufficient balance to fulfill the certain order.

IDEX Platform – For making or fulfilling an order on the IDEX Cryptocurrency exchange, the users have to deposit tokens from their Ethereum wallet to the smart contract deployed at the IDEX platform. The users have to then use the IDEX application interface for placing buy and sell orders on the off-chain orderbook. The integration of this off-chain orderbook in the IDEX decentralized Cryptocurrency exchange is similar to that of the one in Etherdelta.

Benefits of off-chain orderbook – Now that we have discussed the whole premise of an off-chain orderbook including how they work and why we need them. It is important to understand their benefits before we set out to figure how to make a decentralized Cryptocurrency exchange. Let’s have a look at them:

  1. Performance and Cost – As we discussed at length before, the performance and cost are a very sensitive pain point because of the high gas costs and wait times in the Ethereum blockchain. By leveraging the power of off-chain orderbooks, you can operate a decentralized Cryptocurrency exchange at a very low cost while ensuring that performance is at par.
  2. Rare chances of the exchange getting hacked – Since the OrderBooks are hosted off-chain, it is less vulnerable to espionage and hacks it instances where users may succeed in reversing transactions.
  3. Compatibility with ERC-20 Tokens – Any token that has the ERC-20 technical implementation can be traded on these decentralized exchange protocols.

But why would people spend their own computing power to do someone else’s work?

This is where the concept of incentives comes in. As current cryptocurrencies reward ‘miners’ or transaction verifying agents by issuing currency in their name, a similar incentive scheme needs to be put in place on our exchange in order to encourage verifying parties to stay in the exchange and perform honest practices.

This can be done on the most basic level by giving them a small fee on all the trades that they verify. In order to facilitate this further, one could partner up with banks or other financial firms to bring the concept of fiat currency to process these payments as well.

Partnering with a bank would also be beneficial, as it would lead to faster settlements of payments and addition and withdrawal of fiat currency. Banks can also facilitate payment gateways which is an added bonus. Making a cryptocurrency exchange appication comes with its benefits, you see?

A management system is now needed

Centralized cryptocurrency exchange applications and platforms have a governing body presiding over every trade and transaction that occurs in the system. Exchanges like Mt. Gox and Bitfinex are centralized, and they are completely managed and operated by central organizations. Their eventual hacking and loss of funds of the customers prompted something different to spring up in this field. That is the reason why people started looking into how crypto exchanges work, and why decentralized cryptocurrency exchange applications got the limelight they got.

Decentralized exchanges are the difference that has sprung up. They, as the name suggests, are not controlled by any central body, rather they are autonomous. How to make a decentralized cryptocurrency exchange now has comprehensive answers. But they still need a system to manage the trades taking place on the network.

How is it done?

This can be accomplished by designating some currency holders as the administrators, who receive shares of the fees levied on the transactions. These administrators could be applied for by other nodes of the exchange network in due time so that every one of them stands a fair chance to become an admin and reap the rewards.

Now, certain security measures need to be in place to prevent attackers from buying up all the voting rights and stealing the deposited funds. This can be achieved by changing of admins after an extended delay which can provide customers with ample time to take their money out of the exchange if an attack happens. Not only this, we make sure that the platform we developed is usable enough to make sure that a user doesn’t need to know how crytocurrency exchanges work.


Designing software at both front and backend

After all, the logic has been decided and the administrators have been chosen, and the method of how to make a decentralized cryptocurrency exchange has been decided upon, there must exist some special software with administrator privileges that allow them to watch over the network and perform their job of verifying trades.

Similarly, at the front end, apps or software need to be designed for users to continue trading on the exchanges, a wallet needs to be provided for them to store their currency, and if needs be, any third party may be employed to develop the aforementioned on a safe and secure basis.

Additionally, an API could be created which links your own exchange to other existing exchanges in order to showcase liquidity on the network. Once all of this is done, there is the small matter of…


How to make a decentralized cryptocurrency exchange


Garnering funds, setting up the final applications and customer support and security.

Funds and processing power could be collected by organizing events such as crowdfunding and crowd sales, this would further help in assuring liquidity in the exchange. Customer support channels also need to be set up, since this is a new venture, potential traders are bound to have problems and questions about the working of the exchange. This plays a really important role in the success of your cryptocurrency exchange application.

When all is said and done, you’ve learned how to make a decentralized cryptocurrency exchange application, and the exchange goes live, all you have to do is pray that volumes increase quickly and your exchange becomes the next big thing! And don’t worry about the security, the decentralized nature of the exchange makes it largely resistant to hacks, unlike the centralized exchanges.

Congratulations on taking the first few steps to becoming a crypto legend! You now have a majority of the information on how to make a decentralized cryptocurrency exchange! Okay, so the question ‘How to make a decentralized cryptocurrency exchange’ has been answered! You’ve made your own crypto exchange! Congratulations on making it this far! But the process has just started, and you must keep going.

For the developers looking for information on how to make a decentralized app, check here.

Security. Maintenance. And Management.

Keeping a business going involves so many factors, one might almost lose count of them. There’s maintenance of equipment and personnel, there’s proper handling of clients, management of schedules, practicing efficient techniques, and maybe, most importantly, security. Once you know how to make a decentralized cryptocurrency exchange, you must also know how to keep it secure. When a decentralized cryptocurrency exchange is under consideration, security and protection are of prime importance. No business owner would want to incur losses to both his/her assets and his/her customer’s possessions due to some security flaw in his/her system. We say that security is of prime importance in relation to a currency exchange because,

  1. First of all, it deals with finances and money. People love their money more than most of the things in this world. Therefore, their money must be protected with all that you have.
  2. Secondly, all major work will be done online. Now, there are plenty of hackers out there, who will look to exploit the tiniest flaw that your system might have. You risk losing all that you’ve done in the blink of an eye.

Thus, security and protection must be uncompromising, when you look into how to make a decentralized cryptocurrency exchange. A glaring example of this statement is the Mt. Gox exchange hack of 2014.


Security of Decentralized Cryptocurrency Exchanges.

When you’re trying to figure out how to build a decentralized Cryptocurrency exchange, security must one of the top priorities that you must set. Understandably so, there have been far too many hacks and instances of phishing with cryptocurrency exchanges in the last couple of years to not focus on the security of decentralized cryptocurrency exchanges. Before you kick off your process of building a decentralized exchange, it is of utmost importance to understand the security considerations involved. As you must have understood by now, a DEX has the architecture with no central controlling server and no need of third party escrow intermediary is there for holding the funds of participants. This makes the decentralized ones inherently more secure as compared to their centralized and custodian counterparts. In decentralized exchanges, the transactions are broadcast in such a way that no centralized or custodian third party whatsoever is able to interfere with their trading systems. Let’s discuss the process of order cancellation and order matching for the DEXs.


Order Matching – There are a number of variants of order matching algorithms. 3 of the most common order matching algorithms you should know when you decide to build a decentralized Cryptocurrency exchange are as follows:


  1. FIFO – The first part is called as the ALLOCATION. Maximum allocation of any certain order is provided to the oldest relevant order made as per the best bid/offer. The second part is termed as priority. This involves prioritizing the orders based on their classification between implied orders, implied outright orders and explicit orders.


  1. Pro-Rata – Pro-Rata algorithms are employed to divide incoming orders between orders at the same price level. This is done by keeping a check on the volume of the orders allocated being in proportion to the amount of volume present in the market at the given price. This is termed as a pure ratio based algorithm.


  1. Time Pro-Data – Fractional allowances are rounded off to the a more simple number. This means giving a certain equally sized allocation to the almost same volume orders. Now, the priority is granted based on which one of the orders is older.


These were the things you must know about order matching algorithms if you’re looking for the answer of how to build a decentralized Cryptocurrency exchange. Let’s discuss the dynamics of order cancellation.


Order Cancellation – If you’re talking about the ethereum decentralized Cryptocurrency exchanges, you must know that the transactions on the ethereum blockchain cannot be explicitly outrightly. However, the unwanted transactions can be invalidated, which would lead to their cancellation. For this, the sender has to broadcast another transaction with exactly same nonce but at a higher gas price due to the fact that only one transaction can be cleared with a certain nonce. But the gas price of the new transaction needs to be at least more than 1.1 times of the previous gas price. This is the basic explanation of how order cancellation works that you need to understand to create a decentralized Cryptocurrency exchange.


Trading Engine Attacks in Decentralized Cryptocurrency Exchanges.

While it still stands true that the decentralized Cryptocurrency exchanges are safer, more secure and robust as compared to that of centralized ones, there still are a number of ways a bad actor can attack them. You can have a look at this article about the problems in decentralized cryptocurrency exchanges. Some of the most problematic trading engine attacks which happen regularly are:

  • Font-Running
  • Maker’s Grief
  • Latency of on-chain orderbook.

What happened?

Mt. Gox was the largest bitcoin exchange in the world at the beginning of 2014. It handled over 70% of the total transactions worldwide. One fine day, Mt.Gox fell victim to a massive hack that drained the company of 740000 BTC, equivalent of 460 million euro at the time. Eventually, 200000 bitcoins were recovered, but the rest were never recovered.

It was rumoured that the hack was already in motion since 2011, prior to which, the private keys of the wallets of all the customers were unencrypted, which led to a hacker being able to steal the file related to the wallet of a customer, and gradually eat away at their bitcoins without the company servers detecting this. Thus, by 2013, Mt. Gox had practically lost all of its BTC. The company remains under bankruptcy protection, and the case is still under investigation.

The impact of these incidents.

This whole incident, and many others like this, multiply the need for tight security amongst these exchanges. And reiterate the importance of how to make a decentralized cryptocurrency exchange, and yours is no exception. Your decentralized exchange must be able to handle all kinds of malicious attacks, such as

  1. A DDoS attack
  2. Stealing of authorized or restricted access
  3. Firewall breaches
  4. Suspicious activity in general
  5. Unauthorized access to the accounts
  6. The rogue process due to privileges

And the list goes on. With the advancement of technology every day, new ways are being discovered to break the walls behind which online businesses stand. This makes it important to have a solid foundation and a hackproof business system which can guarantee the safety of assets.

Think of compliance.

When you build your decentralized cryptocurrency exchange, you must also comply with the cryptocurrency security standards (CCSS). In the realm of payments using fiat currencies. The security can be attributed to the Payment Card Industry Data Security Standard (PCI DSS). On a similar note, the CCSS was introduced in 2014 to provide secure management to cryptocurrencies. It is an open standard that focuses on the storage and usage of cryptocurrency within an organization. It is basically a security standard for the wallets that store currencies.


How to make a decentralized cryptocurrency exchange


What can be better than engaging the professionals in a matter as important as security?

Third parties are generally quite efficient in handling specific aspects of businesses that require professional attention. Security, most definitely is one such area. If you are looking to support your business project with the help of third parties, you can look at a costing of about USD 200-2000 monthly, which depends on the location and area of operation.

You could also look to seek professional help when it comes to developing the applications and APIs for your exchange, or for customer support operations as well. So there it is! This is all you need to know in regards to how to make a decentralized cryptocurrency exchange!


Our Decentralized Cryptocurrency Exchange Solution.


How to make a decentralized cryptocurrency exchange


We have created a White-Label decentralized cryptocurrency exchange solution with a number of unique features, as well as robust technology. We managed to come up with a number of solutions of problems like Front-Running and Makers Grief. Our decentralized exchange development was mainly focused on adding features that actually add value in the trading, for the traders as well as DEX owners.

One of these features is the Shared Liquidity in which the decentralized exchanges are able to have access to a wider liquidity pool, which makes it a better experience for traders, as well as increase the profits for the exchange owners. We have been working on other features which will help make the exchanges faster and more secure. These include atomic swaps, on-chain trading, and the plasma protocol. You can contact us to get a closer look at our cryptocurrency exchange application.

Sounds too big of a task for you? We have it covered!

At Sodio, we look to provide our customers with the best there is in regards to Blockchain. We offer industry-disrupting solutions to your blockchain problems, such as how to make a decentralized cryptocurrency exchange, and can certainly assist you in building your own cryptocurrency exchange application. This is all made possible by our talented team of 20+ blockchain developers, who are equally skilled and experienced in all kinds of projects.

Contact us if you would like solutions to all your crypto and blockchain problems! Our team would be happy to help you.


Get in touch!


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