Decentralized Exchanges Vs. Centralized Exchanges
Why Crypto Exchanges will move to a decentralized model.
By way of introduction, there are basically two types of exchange systems, which are the centralized exchange system and the decentralized exchange system.
Centralized Exchanges (CCE)
A centralized cryptocurrency exchange is a platform that handles the exchange (purchase/sale) of cryptocurrency to fiat. It is usually run by a profit-oriented company that gets revenue from their platform’s fee structures. The centralized cryptocurrency exchanges enjoy support and acceptance among traders because decentralized exchanges are still in the infancy stage and are not very popular. However, on the negative side, funds are in control of the exchange and there is lack of anonymity, and the risk of identity theft is increased as users are usually required to provide a wide range of sensitive information about themselves. Further, exchanges are not immune to hacks, as was the case with Poloniex, one of the busiest exchanges of cryptocurrency which was hacked in the summer of 2014 when hackers were able to exploit a faulty withdrawal code resulting in users losing funds. Bitstamp suffered a similar fate in January of 2015 resulting in a huge loss (about 19000 bitcoins).
Decentralized Exchanges (DEX)
Unlike centralized exchanges, decentralized exchanges aren’t coordinated by one entity. Instead, they run on a distributed ledger, like cryptocurrencies themselves do. This structure means that a decentralized exchange does not hold customers’ funds, positions, or information, and only serves as a matching and routing layer for trade orders. This benefits the user in so many ways.
Secure
The chief benefit of a decentralized exchange is that a trader does not have to entrust his/her funds to anyone. Instead, he/she trades directly with another party, using a blockchain to finalize the operation. They hold their funds in a digital wallet and trade them using the decentralized exchange to find a buyer or seller for her coins. This eliminates custody risk, which is the risk that something bad 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 your money.
Massive security attacks, such as the roughly $470 million that was stolen from Mt. Gox, were only possible because the centralized hot wallets of the exchange were targeted, which presented a single point of failure. In a DEX, each user is in private control of their own funds, so there is no central point of attack.
Resistant
Another benefit is that decentralized exchange model has no central authority making it more resistant to outside influencers such as regulators/government. In the traditional banking system, a government can unrightfully lay claim to the assets of an individual or group and seize them at the bank level, preventing access. Because a centralized exchange operates as a standard business with a physical location and registry with authorities, it is also liable to being unrightfully shutdown or having assets seized. This reduces the practical benefits of censorship resistance to those living under a corrupt government by limiting their ability to transact. Decentralized exchanges run on a distributed ledger and cannot be shut down or tampered with in this way.
Trustworthy
Furthermore, in decentralized exchanges, there is a high level of privacy, minimizing the risk of sensitive information getting to the wrong hands. The user’s private details are safe and secure which is a big plus, in a world where security of personal information is becoming a big problem.
On paper, decentralized exchanges are a perfect solution for the concerns raised by centralized exchanges. There is a general consensus in the crypto community that decentralized exchanges will take on a more prominent role. But there are downsides to decentralized exchanges in their current state that could be improved upon, such as:
- Complex interface: One reason that centralized exchanges have become so popular is that they make participating in the cryptocurrency market simple. Users are provided with an email and password combination and do not need to worry about managing their private keys. At the moment, decentralized exchanges lack a simple user interface and user experience which limits their reach.
- Limited functionality: Decentralized exchanges offer limited functionality compared to centralized exchanges. This is usually a limitation in order type (no stop loss or limit order available) or lack of breadth of coins to trade.
- Low trade volume: Because of the previous two shortcomings of decentralized exchanges (complex interface and limited functionality), there is low transaction volume which means that it may be hard to find a counter-party for a trade.
To sum up, despite some minor drawbacks, LiveTrade believes that the future of decentralized exchanges seems so bright at the moment as users are actively seeking more control over the security of their currencies.
