The Role of Decentralized Crypto Exchanges and Why Community Power Matters by@openware

The Role of Decentralized Crypto Exchanges and Why Community Power Matters

Centralized exchanges (CEXs) currently dominate the cryptocurrency trading industry, while decentralized exchanges (DEXs) are rapidly growing in popularity. Decentralized exchanges facilitate peer-to-peer trading through having automated smart contracts execute the trades, which leaves out any need for an intermediary. Centralized cryptocurrency exchanges keep the cryptocurrency assets for their customers - for the buyers and the sellers - and control the private keys required to access the funds. The decentralized exchanges allow cryptocurrency investors to hold onto their keys while trading by using liquidity solutions from order books to liquidity pools.
image
Openware Hacker Noon profile picture

Openware

Crypto Exchange Foundry

  • Decentralized crypto exchanges (DEX) bring control back to the hands of their users through community voting.
  • Most of them allow users a way to earn returns on their cryptocurrency deposits.
  • Centralized exchanges are still an appealing option for new cryptocurrency users who want a simple trading experience.
  • Centralized exchanges retain control over your wallet's private keys, which can prove handy if you lose them, but come at the cost of losing complete control over your crypto assets stored on the exchange wallet.

Cryptocurrency exchanges are a source of liquidity to the global cryptocurrency market.  They are responsible for facilitating billions of dollars worth of crypto liquidity daily.

Suppose you have decided to purchase a cryptocurrency token at some point in time historically. In that case, the chances are high that you have at least heard of some of the most popular crypto exchanges, such as Bitstamp, Kraken, and Coinbase.

All of the above examples are centralized exchanges (CEX) - meaning the trading activities and crypto assets are done on the exchange platform in a controlled environment. 

The decentralized exchanges allow cryptocurrency investors to hold onto their keys while trading by using liquidity solutions from order books to liquidity pools. The crypto assets never leave the trader’s wallet, and the DEX platform does not control the user’s assets.

Centralized exchanges (CEXs) currently dominate the cryptocurrency trading industry, while decentralized exchanges (DEXs) are rapidly growing in popularity. Let's see exactly why this is the case and what the are the main differences them.

Decentralized Exchanges and the Role They Play

Decentralized Exchanges facilitate peer-to-peer trading through having automated smart contracts execute the trades, which leaves out any need for an intermediary. Not all DEXs employ a similar underlying infrastructure. Some remain with the conventional order book models, while others take advantage of liquidity pools.

Decentralized exchanges typically enable near-instantaneous trades, often at a much lower cost when compared to what is offered on centralized exchanges due to their reliance on self-executing smart contracts.

The Main Advantages of Centralized Exchanges that Make Them Appealing 

A centralized cryptocurrency exchange model essentially works like this: users deposit their funds in the exchange. In turn, they are issued a native platform cryptocurrency token - think of it as an IOU (“I owe you”) note. That note can be traded freely on the platform. When a user wants to withdraw the funds, these IOUs are converted back into their chosen cryptocurrency.

Centralized cryptocurrency exchanges keep the cryptocurrency assets for their customers - for the buyers and the sellers. They control the private keys required to access the funds. The main benefit for the users is that they can just log in with their account credentials and not worry about storing their private keys, passcodes, and passphrases.

One too many crypto exchanges have gotten hacked by either internal or external breaches, and the decentralized exchanges are the native solution to the issue.

Where Decentralized Exchanges Fit into The Picture

One of the main reasons cryptocurrency traders opt-in to use decentralized exchanges is to retain complete control over their assets. Traders simply connect to the DEX platform, while their crypto never leaves the safety of their cryptocurrency wallet.

A decentralized exchange lets you trade cryptocurrency on a decentralized ledger while controlling your keys and funds. If you lose your password to a centralized exchange account, you can always reset it through the customer support service. In contrast, if you lose your passcode or passphrases to the personal DEX wallet, that wallet is lost forever.

Decentralized exchanges also have lower, at times even zero fees, and can do so through a model known as the Automated Market Maker (AMM). Through AMMs, the traditional order book is replaced by liquidity pools. These liquidity pools are pre-funded for both cryptocurrency assets in a trading pair.

Through this method, the liquidity is provided by the network of users who can earn passive income on their deposited funds through the fees generated on the pool, where they get a percentage based on the amount of liquidity they have staked within the pool.

The custody is distributed across the entire user base within these decentralized exchanges, making attacks much more challenging and expensive to execute. This lack of an intermediary also means that many decentralized exchanges also have limited counterparty risk since the individual users fully control the funds. 

Decentralized Exchanges Aren't Perfect, and This is Why Centralized Exchanges Are Still Popular

While centralized exchanges also have their flaws, such as being controlled by a central authority and being more susceptible to attacks due to their centralized nature, decentralized exchanges aren't perfect either.

Institutional investors are deterred from DEXs due to the lack of liquidity alongside their current adoption levels. Additionally, for cryptocurrency beginners, centralized exchanges are just easier to get into when trading for the very first time. You can recover if you make a mistake; it's not a huge deal, unlike DEXs, where you could genuinely lose everything.

Why Certain Traders Choose Decentralized Exchanges

There are a few specific reasons why traders prefer DEX to CEX.

Cheaper Transaction Fees

Trading on decentralized exchanges has much lower fees, and at times, even non-existent fees compared to centralized exchanges.

Low Counterparty Risk

Historically, there have been numerous cases of compromised centralized exchanges, which isn't an issue with decentralized exchanges because cryptocurrency trades occur between people directly through an automated process.

Privacy

Privacy has become an essential part when it comes to cryptocurrency trading for a lot of people. After all, the whole point of the appeal of cryptocurrency is the fact that they are anonymous.

Centralized exchanges, at least the fully regulated and licensed ones, will ask you to go through a KYC (Know-Your-Customer) and AML (Anti-Money Laundering) procedure and request data from your government-issued ID, driver's license, utility bill, and so on. Decentralized exchanges do not request such information from you, you connect your wallet, and you are good to go.

Community Power

Decentralized exchanges will typically have their native cryptocurrency token. Uniswap (V3) has the UNI token, PancakeSwap (V2) has the CAKE token, and SushiSwap has the SUSHI token. There are numerous other DEXs out there, but we will be using these as an example. 

In the case of Uniswap, the holders of the UNI tokens can influence and vote on the development decisions on the DEX as it moves forward. They can also fund grants, partnerships, the liquidity pools with it, and other proposals.

The idea here is to influence the project’s future and help develop the decentralized exchange.

While this sounds amazing on paper, as users know what they want and can lower or raise the fees, for example, or introduce additional tokens into the cryptocurrency exchange that were not available before the vote, it has proven troublesome and sometimes chaotic in some cases.

On the other hand, centralized exchanges typically have employees and developers that make these upgrades based on what that specific exchange has decided it wants to do, not the community. Coinbase and Binance, for example, introduce new features and crypto tokens to their exchange platforms constantly. While their success is based on the community's acceptance and trading level of those specific tokens, the exchange owners decide which token gets added, which feature gets introduced, and what kind of upgrades the exchange receives.

That is yet another reason some traders prefer decentralized exchanges, as they provide the community with actual power to influence the development and overall outcome of how the decentralized exchange will work in the present and the future.

Furthermore, many of the DEX projects are open-source. Their codebase is public, and anyone can fork to create different projects that work similarly, albeit with certain specific differences. This level of freedom is an appealing point for developers as they can essentially develop these technologies as much as they want to.

The Future of Exchanging Cryptocurrencies

While decentralized exchanges offer specific benefits to cryptocurrency trading, centralized exchanges are definitely here to stay.

Centralized exchanges offer users a heightened level of convenience, featuring pre-built wallets that you automatically get when you make an account and straightforward user interfaces for buying cryptocurrencies that anyone can get into.

Additionally, they provide users with the opportunity to buy cryptocurrencies using a credit card, debit card, or PayPal, something you will not find in Decentralized Exchanges. So if you want to dip your toes into the world of cryptocurrency trading for the very first time, centralized exchanges make a lot of sense.

On the other end of the spectrum, decentralized exchanges are the go-to options for advanced traders who know how to take care of their private keys, want to retain complete control over their cryptocurrency assets, and trade at the lowest trading fees possible. They have also gained a high level of popularity because, as a user, you will essentially fund liquidity pools, through which you will get a return on your deposit through a percentage of the trading fees generated on the DEX.

Additionally, decentralized exchanges have their flaws. They have a lackluster user experience compared to centralized options; they offer little to no customer support and typically only facilitate crypto-to-crypto trades. These things will be improved upon over time, and the chances are high that they will become something that centralized exchanges will need to worry about.

Thank You for Reading

Make sure to visit Openware Crypto Exchange Foundry to learn more about DeFi and Blockchain technologies, cryptocurrency exchange software solutions, and open-source developer tools for launching next-generation Crypto & Blockchain projects.

Did you enjoy reading the article? Subscribe to the newsletter in the footer below get more stories from open-source Blockchain software engineers at Openware!

Tags

Join Hacker Noon

Create your free account to unlock your custom reading experience.