An Introduction to Decentralized Exchanges was written by FlatOutCrypto, and it’s included in issue #15 of 21Cryptos Magazine. To read more articles like this subscribe today. To read other free articles check out our Magazine category. Follow us on Instagram, Facebook and LinkedIn.
This article is from an earlier date and as such can contain figures that were actual at time of writing.
Crypto trading has been largely restricted to exchanges operated by third-party organizations, known as centralized exchanges (CEXs). Users deposit funds to the exchange, and the CEX is then responsible for the safekeeping of these funds until withdrawn again. CEXs act in a similar manner to banks – user funds are pooled together upon deposit and are then only split up at withdrawal. Because of the centralized management, trading is swift and transactions can happen instantly because everything is stored on an internal database.
By contrast, decentralized exchanges (DEXs) are implemented by a thirdparty operator, but are not managed in the same way. Trades are peer to peer, with the two parties trading between themselves. As a result of this decentralization, DEXs boast several key advantages:
- Owing to the frequency of exchange failures, including fraudulent owners and cybersecurity risks such as hacks, potentially a DEXs biggest advantage is allowing users to always be in control of their own funds (as trades are P2P);
- Listing fees can run into millions on larger exchanges, but DEXs can allow for any token to be traded easily and quickly, providing a lifeline for smaller projects which cannot afford to pay for listings. In the case of DEXs such as EtherDelta, there isn’t a listing process – users can trade against the contract address;
- DEXs don’t use passwords, usernames or 2FA, as trading is direct from the user’s wallet. By removing the need to log-in, the process is considerably streamlined;
- Unlike CEXs, which must (or should have to) comply with stringent Know Your Customer (KYC) and Anti Money Laundering (AML) rules, DEXs can have no operator and allow trading direct from user wallets. As such, DEXs can operate across jurisdictions and without needing to submit to KYC/AML laws. Whether or not this is perceived as an advantage of disadvantage depends upon your perspective;
However, DEXs have their disadvantages too.
Because all transactions take place on the blockchain, they are slower than CEXs. They are also less reliable as a result, with already filled orders sometimes not being removed from the order book quickly enough, leading to frustration from users who are left wondering why the order they are trying to fill won’t let them.
Furthermore, they have significantly less users than the largest CEXs and accordingly have less volume too. While the largest CEXs will transact billions daily, even the leading DEXs will transact in the low millions (although this has been as high as $20-40m in January to March). This lack of liquidity makes DEXs borderline unusable for many token pairings, with spreads (the difference between the highest buy and sell orders) high. Finally, some DEXs are not wholly decentralized; for example IDEX, one of the larger DEXs, terms itself as a hybrid CEX/DEX, and as such intends to implement KYC and has delisted tokens it deems as securities.
Thus far the DEX space has seen hundreds of entrants struggle to attain dominance. However, the exchange juggernaut Binance recently showed off its plans for a DEX of its own, a move that will radically alter the landscape.