How do decentralised wallets work

"A decentralised exchange (DEX) is a cryptocurrency exchange that operates in a decentralised way with no central authority. Decentralised exchanges make allowance for peer-to-peer trading of cryptocurrencies."

The nature of cryptocurrency wallet operation can be demonstrated as: a customer wires money to an exchange's bank account and then waits several days for those funds to be credited to the exchange account. Once the funds are in, the customers can buy or sell crypto coins with those funds.

During this time, the exchange holds the funds, whether in fiat or cryptocurrency and takes responsibility for keeping them safe. When having finished the trading, the customer could swap the funds into either fiat - a kind of cryptocurrency or have that amount wired back to their original bank account.

The chief benefit of a decentralised exchange is that a trader does not have to entrust the customers' funds to anyone. Instead, they trade directly with another party, using a blockchain to finalise the operation. They hold their funds in the digital wallet and trade them using the decentralised exchange to find a buyer or seller for their coins. This eliminates custody risk, which is the risk that something wrong happens to the customer’s funds while the exchange operator is in charge of them. That includes losing funds to hackers or having to trust that the operator is not doing anything suspicious with money.

Source: crypto.com

If customers want to get the total benefits of cryptocurrencies, it is essential to store their coins in decentralised wallets. These are wallets that make the sole custodian of investments, which means that they control the private keys rather than some other entity (such as an exchange).

While cryptocurrency exchange can be convenient for a third party to hold funds since they typically offer protections or other benefits, there are also negatives that if the service becomes insolvent or turns out not to be trustworthy, then the funds will be gone forever, and will have no way to recover them.

Users do not need to transfer their assets to the exchange. Decentralised exchanges decrease the risk of being stolen from hacking. These can also dampen price manipulation or faked trading volume through wash trading, and are more anonymous than exchanges which implement know the customer requirements. There are some signs that decentralised exchanges have been suffering from low trading volumes and market liquidity. For example, the 0x project, a protocol for building decentralised exchanges with interchangeable liquidity attempts to solve this issue.

Source: scmp.com

Disadvantages of decentralised wallets

A lack of KYC process without reverting a transaction, users are at a loss if they are ever hacked for their passwords or private keys.

Degrees of decentralisation

A decentralised exchange indeed could own centralised components, whereby some control of the exchange is still in the hands of a central authority. A notable example is IDEX - a company in the USA, which blocked New York State users from placing orders on the platform. Decentralised exchange Bancor was reportedly hacked and suffered a loss of $13.5M in assets before freezing funds In July 2018. Charlie Lee, the creator of Litecoin, spoke out and claimed an exchange could not be decentralised if it can lose or freeze customer funds on his Tweeter account. Besides, operators of decentralised exchanges can face legal consequences from government regulators. One example is the founder of EtherDelta, who settled charges with the U.S Securities and Exchange Commission over operating an unregistered securities exchange in November 2018.