What are decentralized exchanges?

"When trading cryptocurrencies, you need an exchange, but many are truly centralized and run by one company. This went against the main characteristics of the cryptocurrency, and so decentralized exchanges were born."

These exchanges have a trading platform that works like a peer-to-peer network, and they provide services over a distributed network. The result is an exchange where users can trade their cryptocurrency without having to worry about unreliable centralized exchanges or government agencies stealing their money.

From Bitcoin's early days, exchanges have played a key role in matching crypto buyers with sellers.

Source: blockchain.news

Defining decentralized exchanges

A decentralized exchange (DEX) is a cryptocurrency exchange that works in a decentralized way, that is, without a central authority. Decentralized exchanges allow peer-to-peer trading of cryptocurrencies.

Because users do not need to transfer their assets to exchanges, decentralized exchanges reduce the risk of theft from hacking exchanges. Decentralized exchanges can also prevent fake price or volume manipulation through wash trading and are more anonymous than exchanges that fulfill your client's request.

How a decentralized exchange works

Nearly everyone in the blockchain world agrees that decentralized exchanges (DEXs) are the future of cryptocurrency trading. That's because, even in 2020, trading digital assets is still a headache.

To start trading, you must first buy assets in fiat currency (USD, EUR, GBP, AUD, etc.) through fiat gateway services, which typically charge high fees and low exchange rates. Furthermore, the exchange will keep the private keys of coins and tokens for you. As a result, exchanges have to manage a few centralized wallets in order to control the vast amount of assets. This concentration of wealth makes exchanges the perfect target for the bad guys. Hackers have been stealing digital assets worth billions of dollars over the past few years, highlighting a major security issue for the entire blockchain industry.

The solution is decentralized. If all transactions were completely peer-to-peer, like on a decentralized exchange, then middlemen would no longer need to hold and manage users' money. It makes cryptocurrency transactions much more secure. It also promotes adoption by simplifying the transactional process.

Source: news.bitcoin.com

Advantages of DEXs

• No KYC

KYC / AML (Know Your Client and Anti-Money Laundering) compliance is standard across many exchanges. For regulatory reasons, individuals are typically required to submit identification and proof of address.

This is a privacy concern of some and an accessibility concern for others. What if you don't have valid documents on hand? What if the information was leaked somehow? Since DEX is not allowed, no one can check your identity. All you need is a cryptocurrency wallet.

However, there are some legal requirements when a DEX is partially operated by a central authority. In some cases, if the order book is centralized, the host must comply.

• No counterparty risk

The main attraction of decentralized cryptocurrency exchanges is that they do not hold client funds. Hence, even serious breaches like the 2014 Mt. Gox hack will not put the user's money at risk or reveal any sensitive personal information.

• Unlisted tokens

Tokens not listed on centralized exchanges can still be freely traded on DEXs, as long as there is supply and demand.

• Faster and cheaper transactions

DEX can facilitate faster and cheaper transactions than a centralized exchange since there are no third-party validators. Currently, this is only theoretical and has not been demonstrated by exchanges on a large scale, as the DEXs have not yet achieved the "network effect" in reaching enough users for the critical masses.

Disadvantages of DEXs

• Usability

In fact, DEX is not nearly as user-friendly as traditional exchanges. Centralized platforms provide transactions in real-time without being affected by block times. For those new to non-custodial crypto wallets, CEX offers a more forgiving experience. If you forgot your password, just reset it. However, if you lose your seed phrase, your money will be irreversibly lost in cyberspace.

• Fees

Fees are not always higher on the DEX, but they can be higher, especially when the network is congested or if you are using an online order book.

• Lack of functionality

The biggest drawback of DEXs right now is the lack of functionality, associated with centralized exchanges. Most DEXs only support basic market functions and don't even have features like margin trading and stop loss. The technology simply hasn't kept pace with the ambitions of most decentralized exchanges, although DEXs like BlockDX are planning to support additional functionality.

Conclusion

Many decentralized exchanges have emerged over the years, each repeating previous efforts to streamline the user experience and build more robust exchange locations. Ultimately, the idea seems to fit the ethos of autonomy: as with cryptocurrencies, users don't need to trust a third party.

With the rise of Decentralized Finance, Ethereum-based DEXs have seen a significant increase in usage. If the momentum continues, we will likely see increasing innovation in technology across the industry.

REFERENCES

Decentralized Exchanges (DEX): Comparing The Top 8 DEXs. (2020, August 14). Retrieved November 13, 2020, from https://komodoplatform.com/decentralized-exchange/

Binance Academy. (2020, October 08). What Is a Decentralized Exchange (DEX)? Retrieved November 13, 2020, from https://academy.binance.com/en/articles/what-is-a-decentralized-exchange-dex

Jurado, I., & León, S. (2020, May 04). Economic globalization and decentralization: A centrifugal or centripetal relationship? Retrieved November 13, 2020, from https://onlinelibrary.wiley.com/doi/full/10.1111/gove.12496

Decentralized exchange. (2020, October 19). Retrieved November 13, 2020, from https://en.wikipedia.org/wiki/Decentralized_exchange

Author, & Blockgeeks. (2020, February 01). 3 Reasons Why You Should Care about Decentralized Exchanges. Retrieved November 13, 2020, from https://blockgeeks.com/guides/decentralized-exchanges/