Bitcoin is a blockchain-based cryptocurrency that allows its users to transfer currency without the involvement of any third-party. The ultimate goal of Bitcoin is to return its control of money to its owners. But, bitcoin is delegated to third-party services regularly. These are the exchanges.
Centralized exchanges are easy to use, easy to access and they offer trading functionalities like margin trading. But, these exchanges have a certain security risk for your funds. Users want to exchange their crypto assets.
There are certain items and services that cannot be bought with Bitcoins or other cryptocurrencies. So, you will have to exchange them for their national fiat currency. There are a few cryptocurrencies like Ether (ETH) or Monero (XMR) that offer special features or tools which are not offered by Bitcoin.
So, to exchange your coins without the use of third-party exchanges, you will have to use decentralized exchanges (DEXs).
Now, let’s understand what are DEXs, how they work, and much more.
What are decentralized exchanges (DEX)?
A decentralized exchange that does not depend on any third-party services to hold the customer’s funds. Trading is carried out in a peer-to-peer process. These exchanges are non-custodial, as it allows you to hold the private keys to your wallets. Centralized exchanges are controlled by the central authority and are custodial, it means the exchange platform holds the keys to your wallets. The exchange controls your assets.
Decentralized exchanges use smart contracts to enable peer-to-peer trading. These exchanges are cryptographic in nature. DEXs have notable aspects like they’re non-custodial, automated, cost-efficient, globally accessible, intuitive, and pseudo-anonymous.
How do DEXs work?
Decentralized Exchanges eliminate the need for middlemen and middlemen fees. They also offer a form of security because buyers and sellers do not have to give their information to any 3rd party. Some parts of the DEX can be centralized. A few exchange operators maintain centralized control over some components of their platforms.
For example, the Bancor exchange confined all funds after being hacked for $13.5 million in assets. The U.S. Securities and Exchange Commission (SEC) held EtherDelta founder Zachary Coburn. Considering him responsible for operating an illegal exchange, and imposed a fine of $388,000.
Decentralized Exchanges are programmed in the following way:
- A base decentralized exchange protocol.
- A database order book.
- A graphical user interface (GUI).
- Application programming interfaces (APIs) that offer functionality.
- It is possible to trade centralized currencies on the DEXs and vice versa.
Advantages of DEXs
Decentralized Exchanges offer various advantages that are as follows:
DEXs does not store user assets. Neither hacker attacks nor the total collapse of the exchange can lead to the loss of funds. Decentralized exchanges perform decentralized settlement for orders. Hence, it minimized the potential attack vectors for hackers to exploit. Also, in some cases, the probability of an attack to occur is almost negligible.
In DEX, users can maintain complete custody of their funds placed in escrow while trading. Hence, it offers peace of mind in the security of their funds. In case te DES stops functioning, the user can recover their funds after the escrow transaction is expired.
Minimal Risk of Price Manipulation
The decentralized exchanges do not have any centralized entity or order book to maintain and execute trades. Hence, it minimizes the risk of manipulation. Previously, several exchanges were accused of wash trading to create fake volume and cutting off deposits and withdrawals on tokens at key trading times. As there is no central authority involved, there is less potential for such manipulative behavior to take place.
Privacy and anonymity are the primary offerings in decentralized exchanges. These exchanges will only require your username, password, and crypto wallet to begin trading. For those who prefer to sign up and begin trading without having to go through KYC, DEX is the best option. Also, for those who want to be able to deposit, trade, and withdraw funds quickly, decentralized exchanges are a great platform.
As there is no central entity supervising the trades and orders conducted on a DEX, a decentralized exchange provides greater censorship resistance. Government officials, authorities, and even hackers cannot directly interfere and stop the trades from occurring. As DEXs do not have any central entity or party running the show, it is hard for any DEX to shut down and be censored.
Disadvantages of DEXs
While DEXs offer various advantages, there a few disadvantages as well:
Cannot restore access
DEXs do not include the KYC process. Also, you cannot cancel a transaction if the passwords are broken or there is a loss of the private key. Hence, you cannot recover your data in such cases. Due to the distributed registry, chargeback, and refund procedures are incompatible. If a user has committed an operation by mistake or has lost control over their keys, then it is impossible to recover their access.
Most DEXs do not have many options like stop-loss, margin trading, or lending. DEXs are managed by smart contracts. So, the cryptocurrencies that do not support interaction with smart contracts will not be able to bargain on them.
Blockchain transactions will take time to be checked and confirmed. The processing time completely depends on the exchange and not on the miners. When compared to centralized exchanges, DEXs are less popular, so users may face some difficulty in finding their right match to buy or sell orders or make a deal at a good price.
With all the revolutions occurring in the cryptocurrency and blockchain industry, an evolution in the field of exchanges is also likely to happen. If more and more people begin managing cryptocurrencies as an asset, the DEXs will become a trend in the future of the crypto and blockchain industry.