I understand the coloring part, but I don't get how this paves the way for distributed exchanges. What am I missing?
It really doesn't pave the way. But don't worry, the guys over at Mastercoin have already solved that and they have their distributed exchange up and running. It is not just a pipe dream - it is actual software which executes.
We implemented decentralized exchange back in January. It worked, people made transactions with it.
I've described the difference between colored coins and Mastercoin approaches here:
https://bitcointalk.org/index.php?topic=265488.msg3487339#msg3487339I am still trying to wrap my head around how we get cash $ into and out of a decentralized exchange. If someone can help me there I would really appreciate it.