What are Decentralised Exchanges?
What are decentralised exchanges and how do they differ from traditional centralised exchanges like Bittrex, Binance, etc.? To understand the difference between the two one must first take a look at how a centralised exchange works.
Centralised Exchanges:
For ease, I will use Bittrex as an example of a decentralised network. The way Bittrex works is that users deposit their cryptocurrency on the platform and they can trade using three different pairs: USDT, Ethereum and Bitcoin. They can exchange these for other cryptocurrencies and vice versa. However, when a transaction occurs on the platform, no blockchain technology is involved. The reason behind this that when a user deposits cryptocurrency on the platform, it is all stored together in a "secure vault". Meanwhile, a spreadsheet records that User X has Y amount of cryptocurrency Z in their account which they can trade with (E.g. Cryptolad has 5 Bitcoin in his account). Thus, when a transaction occurs between 2 users the only change happening is on the spreadsheet, cryptocurrency is not actually moving. That is why for example Coinbase only stores 2% of cryptocurrency is hold online; the rest is in secure vaults. This 2% includes deposits made onto the platform and covers any outgoing transaction to other wallets (E.g. a transfer to Bittrex).
Pros:
Allows for many different types of transactions such as limit buy/sell
Cryptocurrency is insured
Easier to use
Most cryptocurrencies listed are checked for reliability
Cons:
Not anonymous, users must register via KYC verification
Exchanges may get hacked and servers may be down for maintenance
New cryptocurrencies have a hard time getting listed on centralised exchanges and must usually pay a fee
Decentralised exchanges:
These exchanges work differently in that cryptocurrency is not transferred to the actual platform. Decentralised exchanges work via atomic swaps which rely on a "trustless" concept; the cryptocurrency exchange does not hold the user's cryptocurrency. Users both keep their cryptocurrency in a personal wallet on their computer and when a transaction is executed the two exchange cryptocurrencies. This is considered a p2p trade as there are no intermediaries, the market exchange does not actually hold on to any cryptocurrency during the transaction; it is a pure p2p exchange. These transactions work via atomic swaps; which allow the cryptocurrencies to be exchanged between the users at the same instant, with neither user holding both assets simultaneously. The benefit of this is that as the transaction is encompassed in one instruction the system cannot be tricked or hacked into letting one user keep both assets.
Most decentralised exchanges work on the Ethereum network within the smart contract system using the ERC20 token. The ERC20 token is the standard way to build a cryptocurrency on the Ethereum network. Most ICOs are based on this network and it allows them to be listed on decentralised exchanges without the need to get the exchange's permission and pay a fee as is the case for centralised exchanges. As long as the cryptocurrency is ERC20 based users can trade them on most decentralised exchanges with no complications. One of the key differences between the two types of exchanges is that users of decentralised exchanges incur higher fees as the transactions occur via wallet transfers and these fees are higher than those charged by centralised exchanges internally.
Pros:
Anonymous, KYC verification and registration is not required, a user may remain completely anonymous
User controls the fund - it is a "trustless" exchange
No hack and server maintenance times as the exchange has no cryptocurrencies stored on it
Cons:
Users incur a fee as the transactions occur between user wallets
Some platforms say they are decentralised exchanges when really they are a scam
Cryptocurrencies for sale may be a scam and as they are not checked by the exchange for reliability, users must perform their own due diligence
Examples of decentralised exchanges:
Bitsquare
IDEX
Waves Dex
These are 3 different decentralised exchanges for those interested in checking them out, next weeks article will involve reviewing these exchanges and as per usual giving them a rating out of 10.
Overall:
It's up to the individual to choose what they want to use, personally, I believe decentralised exchanges have a long way to go before I begin feeling comfortable using them for my day to day trading. This opinion will be evident in next weeks article reviewing these decentralised exchanges.
Cryptolad over and out!
Disclaimer: This article expresses our personal opinions, predictions, and market speculations based on the way we interpret the information we have available to us. It is by no means to be considered expert advice. We take no responsibility/ liability for any actions taken by you based on anything we have mentioned.
We are in no way affiliated with any companies, sites, crypto-currency exchanges and crypto-currencies that we mention in these articles, these are simply the ones we choose to use due to our personal preference.
