Everything You Need to Know About Decentralized Exchanges

While a centralized cryptocurrency exchange is just like the stock market or traditional brokerages, owned and operated by a figure of central authority, a Decentralized Exchange has no central figure of authority. It utilizes blockchain technology to perform exchanges between cryptocurrencies. A decentralized exchange only works as a matching and routing layer for the people with trade orders.

A decentralized exchange is one which does not need or apply a third party bitcoin wallet apps service to store the cryptocurrency of the users. The trades instead happens directly between the users with an automatic process. These systems are created by creating proxy tokens that represent a certain cryptocurrency or fiat money. 

The difference between a decentralized and centralized exchange is in the way funds are handled. In the case of centralized currency exchange, the user will have to create an account with the crypto exchange service. Once that account is up and running, they have to send some money from their own crypto wallet to their account on the exchange platform. This money, whether in the form of cryptocurrency or fiat money, will be held by the exchange platform until the user trades it with another currency. Once they trade it, they can withdraw that money.

With a decentralized exchange, the user doesn’t have to entrust their funds in the hands of the centralized exchange at all. Rather, they would directly find another party using the blockchain technology and use smart contract to finalize the entire transaction. The funds are held in their digital wallet and use the DEx system to trade it with other users. 

So far it sounds pretty good, but for any blockchain application development company, it is important to know whether decentralized bitcoin exchange platforms are reliable or not? Let’s inspect the pros and cons to see whether the decentralized systems are better than the centralized exchange systems.

Is It Reliable? Pros And Cons

Whenever there are two different ways of doing one single thing, the market gets divided on which is the right way of doing it. Just like that, the cryptocurrency world is divided into two regarding the centralized vs decentralized exchange. 

Whether decentralized exchange is reliable or not, it can only be determined through a thorough inspection of the pros and the cons of the decentralized system. 

Even though decentralized exchange system is still at its initial phase, there are still many pros of this system. These are-

No Central Figure

The most obvious positive side of a decentralized exchange system is the absence of a central figure. By cutting out the middleman, decentralized exchanges create a peer-to-peer exchange network where, rather than entrusting the central authority with their funds, the users find traders for their currency themselves through blockchain technology. 

Decentralization of the exchange system creates resistance to censorship. No centralized authority can impose unwanted rules and regulations forcefully. Without the existence of decentralized systems, the exchange systems would become a subject to government regulations, which will affect the privacy and freedom of the users negatively. 

Maximized Security

While there are numerous stories of security problems with centralized exchange platforms, decentralized exchanges are almost free of security issues. While the centralized exchange, the hot wallets used to store the user funds can be targeted as a single point of vulnerability. As proven by the Mt. Gox hack of 2014, not even the world’s most popular and biggest crypto exchange is secure from cyber attack. As a result of this 2014 hack, the users of this centralized exchange lost around $460 million. Ever since then there have been numerous cyber attacks on the centralized exchange platforms, causing loses of millions of dollars. 

With a decentralized exchange system, however, this kind of cyber attack happens less. The decentralized systems utilize blockchain based distributed ledger technology. Not to mention, the users are in control of their own funds instead of trusting on any single point of authority. And that’s why there is no central point for the hackers to attack or manipulate to gain access to the funds. 

Faster And More Affordable

The decentralized exchange system offers a faster and affordable way of trading your cryptocurrency. By cutting out the middleman, aka the central exchange authority, the decentralized system cuts out the trading fees and the time it will take for the trading platform to find a suitable trade for you. Once you have those obstacles out of the way, you can get on to trading your crypto assets easily. 

However flawless the system might look, there are still some flaws with the decentralized exchange system. These flaws are

Lack Of Functionality

Probably the biggest problem of this system is the lack of functionality. The decentralized exchange system is still very new to the market and as a result, there is a simple functionality gap when it is compared to the centralized exchange. The technology has not yet caught up to the ambitions that are surrounding it, even though decentralized supports basic market functions, it still cannot perform actions such as stop loss or margin trading. 

Limited Exchange Capability

The decentralized exchange does not support conversion to fiat currency. However, there is another limitation to the trading capabilities of Decentralized exchange. Due to the lack of KYC authorization process, there is no way for the users to revert back a transfer. Which is why, even if they are hacked (which happens rarely, but still) there is no way for them to get their assets back. 

Decentralized vs Centralized Exchange

When it comes to centralized vs decentralized cryptocurrency exchange, there are a few points that can be mentioned,

Firstly, the centralized exchange platforms are considered to be easier for new digital currency traders. The centralized exchanges offer more than just exchange services to the users, such as stop loses, margin trading, and lending. Many centralized exchanges work as a gateway for the crypto to fiat currency exchange. And that is the reason why they have to be regulated by their country’s Know Your Customer (KYC) policy and Anti-Money Laundering (AML) laws. 

However, the problem people point out about the centralized system is the obvious vulnerability of the system. Along with that, the Mt. Gox hack, the Coincheck Inc.’s $500 million hack in 2018, and Bancor’s $23 million stolen currency stand as a proof that the centralized exchanges are highly susceptible to cyber attacks. And that’s how the entire centralized exchange vs decentralized exchange begins. 

And as a result of this central point of vulnerability, the decentralized exchange system has emerged. Unlike the central exchange system, the DEx system stayed true to bitcoin’s decentralized system and uses the distributed ledger technology to perform the exchange of currencies. Rather than having to trust the central authority with their funds, the users in this exchange are in complete control of their own funds and exchange the currency directly through the P2P system than going through the intermediary. The decentralized system offers its users autonomy and customization they relinquished to the centralized trading platforms. 

The only drawbacks the decentralized exchange system has is due to the fact that it is an incredibly new concept for cryptocurrency exchange. It might lack the functionality, flexibility, and scalability right now, but as the system is explored more and more with time, it will surely grow into the expectations people have for it. 

Conclusion

So what is the final word on the decentralized exchange system?

Just like once bitcoin was a new concept, the concept of a decentralized exchange platform is also a new concept right now. It still has lots of possibilities and needs to be explored and grow more. However, when it comes to the speculations about whether it is reliable or not, we can surely say that for the security of your crypto assets, decentralized exchange system is a more reliable option. Surely by time, it will start offering its users better features and functionality. So it will be a better idea for you, as a trader of digital currency to keep your eyes and ears open about the decentralized exchange platform.