With the current revolution of cryptocurrency, a lot of people are familiar with cryptocurrency exchanges. You get signed up, get a strong password, verify your account, and begin trading in the cryptocurrency.
This is the same as the decentralized exchanges, apart from the initial problems with signing up. Most of the time, you do not have to withdraw or deposit any crypto coin. Decentralized trading is directly done between two users’ wallets with limited (or no) input from a third-party.
Decentralized exchanges are quite elusive to understand and may not have the type of crypto that you need all the time. However, as technology is aimed to grow, this could be an integral part of the cryptocurrency market.
Introduction to decentralized exchanges
From the inception of Bitcoin, exchanges are typically playing a pivotal role in matching buyers of cryptocurrency with sellers. If the exchanges were not known worldwide, there would have been much lower liquidity. The correct prices of assets would not have known to us.
Typically, the centralized exchanges have taken over this field. Due to the fast growth of available technologies, there have been many solutions for decentralized trades.
How do you define the decentralized exchanges?
Theoretically, a decentralized exchange involves any peer-to-peer crypto exchange. However, this post seeks to describe a decentralized exchange that tries to imitate centralized exchanges’ features. One massive difference between the decentralized exchanges from the centralized exchanges is their backend, which seems to exist on the blockchain. Nobody helps you keep your assets on your behalf. Furthermore, you need not trust the exchange in the way that you would with the centralized offerings.
Understanding the way the centralized exchanges operate
With the usual centralized exchange, someone deposits their money through cryptocurrency or fiat (through debit/credit card or bank transfer). The moment that your crypto is deposited, you no longer have any control over it. It can be traded in or withdrawn from a usability perspective, however from a technical standpoint: it doesn’t get spent on the blockchain.
You do not own the private keys to your funds. This means that if you were to withdraw, the exchange is asked to sign up for the transaction for you. The transactions are not done on the chain in centralized exchanges; instead, the exchange balances all the users present on its database.
The overall process is significantly streamlined since slow processing speeds due to the blockchain do not stop trading from happening. Everything happens within a single system. This way, you could easily buy and sell cryptocurrencies. You also have an increased number of tools at your disposal.
However, your trading isn’t independent though. You trust the exchange to keep your money. Due to this, you are usually exposed to certain counterparty risks. You tend to think, “What will happen if the team runs away with your BTC that you have worked hard for?” Or you think, “What if the system gets hacked by a hacker and drains all the funds in it?”
For a lot of users, this risk is pretty realistic. They usually choose trustworthy exchanges with a good reputation and effective secured processes to guard against hackers from their systems.
The way the decentralized exchange is operated
The decentralized exchanges are like centralized exchanges in specific ways, but they can be significantly different. Firstly, it is good to state that we have other decentralized exchanges that users can use. The single common thing among the businesses is that you can execute your orders using a blockchain (using smart contracts), which prevents users from sacrificing the custody of their money at various points.
Specific works were carried out on DEXs with cross-chains; however, the most common ones involve assets on the identical blockchain (like the Binance or the Ethereum Chain).
The advantages and disadvantages of the decentralized exchanges
The benefits of the decentralized exchanges
• There is no KYC involved
The usual thing among businesses is the KYC/AML – known as – Know Your Customer and Anti-Money Laundering) requirements. For reasons having to do with regulations, users are usually meant to submit their identification and address details.
This means both an accessibility concern for people and privacy concern for some others. What happens when a user does not have any valid documents? What happens if someone’s information gets leaked? Since the DEXs do not use any permission, people do not go through your identity. The only thing that you are needed to have is a wallet for your cryptocurrency.
But, then again, some legal standards expect the DEXs to be run partially through a central authority. Some other cases demand that if there is a centralized order book, the host must keep on with compliance.
• There are no counterparty risks
One of the significant attraction points for decentralized cryptocurrency exchanges is that they do not have the funds from customers. In this case, even violent breaches similar to the Mt. Gox hack of 2014 will not put users’ funds at risk. Furthermore, this will prevent any sensitive human information can be stopped from getting breached.
• Unlisted tokens
Tokens that are not listed officially in the centralized exchanges can be freely traded on the DEXs if there are a supply and demand.
Disadvantages of the DEXs
In real life, DEXs doesn’t offer much user-friendliness, unlike the traditional exchanges. Central exchanges come with an instantaneous trading system that is not affected by the block times. For greenhorns and people new to the cryptocurrency market, they might not be familiar with non-custodial crypto wallets. The centralized exchanges offer a more friendly approach. Any forgotten can be reset. But the bad thing here is that your money gets lost in digital space when you misplace your seed phrase.
• Liquidity and trading volumes
The volume of crypto trading on the DEXs is significantly smaller with the Cass. Perhaps, this might be because the DEX tend to come up with greater liquidity. This is a measure of the manner that you could sell or buy assets.
In a market with high liquidity, the bidder and the seller’s price have a slight difference. This is used to show a high-level competition between the seller and the buyer. It can be difficult in an illiquid market looking for someone to trade your asset at a reasonable price.
In DEXs, there are not always higher fees; however, there could be, especially when you seem to have a congested network or when using a blockchain-based order book.
Numerous decentralized exchanges have developed in recent times. Every one of these DEXs is consolidating on the ancient attempts to enhance the experience of the users. They also aim to create more powerful trading venues. Eventually, this idea seems to agree with self-regulatory processes: since when using cryptocurrencies, users are not expected to rely on a third party.