There are two types of cryptocurrency exchanges in operation today, centralized exchanges and decentralized exchanges. Investors should understand the difference between them before trading.
A decentralized exchange (DEX) is a marketplace for cryptocurrencies or blockchain investments that is totally open sourced. Nobody is in control at a DEX, instead buyers and sell deal with each other on a one-on-one basis via peer-peer (P25) trading applications.
A good way to think of a DEX is as a “do-it-yourself trading solution.” You make the trades and hold the funds or instruments in your own account. The biggest advantage to this system is that your funds will be not entrusted to a trading company or other third party.
A centralized exchange operates like a brokerage house, you deposit funds in an account and the exchange makes the trades for you. The advantage to this is that the exchange does all the work, and it is often insured and regulated by authorities.
Most of the large and well-known exchanges; such as GDAX (Coinbase) and CEX.IO are centralized. A popular benefit to these exchanges is that they will take credit or debit card and bank-transfer payments. They may also pay out in fiat currencies like dollars or Euros which many users prefer.
Advantages of a Decentralized Exchange
A lot of traders like DEXs because they have some serious advantages. Strangely enough, these advantages are why a lot of traders distrust decentralized exchanges.
Top advantages of a decentralized exchange can include:
- A DEX can be more resistant to hacking than a centralized exchange because account information is not shared with the exchange operator. Instead ,funds might be kept in your account and you will be the only person with access.
- Theoretically, governments or regulators cannot shut down a DEX because it is decentralized operating through a wide variety of nodes. Note: governments might be able to disrupt or wreck a DEX via malware.
- There is no server which can go down or get hacked. Instead, a DEX operates all over the cloud through a variety of nodes.
- There is a higher degree of privacy because you are not sharing your data with the exchange operator.
- You keep control of your funds in your own account.
- A decentralized exchange can be faster because you make the trades yourself.
Disadvantages to a DEX
Decentralized exchanges are not for everybody because they have some serious drawbacks.
Disadvantages to a DEX that everybody should be aware of include:
- There will be more work involved because you will have to handle chores normally taken care of by a centralized exchange such as making trades and transferring money.
- The funds are not regulated or insured. Regulated exchanges might be required to return the money at any time, so they keep funds in escrow for speedy withdrawals.
- Most DEXs will not take credit or debit card or bank-transfer payment.
- Trading volume is limited which can keep prices low and fees high.
- The services available from decentralized exchanges are limited. Margin trading, stop losses and trades involving fiat currencies will usually not be offered.
- There may be no customer service you can you can contact when there is a problem.
- A DEX can be much more expensive than a centralized exchange because you may need to purchase Ethereum Gas (Ethereum services) every time you make a trade. That means a decentralized trade can sometimes cost several times what a centralized trade would.
Some Popular Decentralized Exchanges
Decentralized exchanges have become popular because they are very easy to find and use. Many people DEXes because they lack some of the barriers that centralized exchanges and cryptocurrency brokers put up.
A few decentralized exchanges have attracted a lot of attention in recent years. Two of the most popular are the Waves Platform and Ether Delta
The Waves Platform
Waves has become very popular because it allows developers to create their own blockchain tokens (altcoins) and trade them through its DEX. A popular use for Waves is the creation of initial cryptocurrency offerings (ICOs) which are becoming widely used as a fundraising tool.
The big advantage to Waves is ease of use, anybody can access its DEX via Waves Client which acts as both a DEX and a cryptocurrency wallet. You can use the client to either trade or to store tokens. The client operates sort of like a bank account users receive interest on their balances and can create a multi-currency wallet that converts altcoins. Mining services are also available through the Waves platform.
Like Ethereum, Waves was a designed as a blockchain ecosystem designed to facilitate a wide variety of tasks including crowdfunding, voting and loyalty programs for businesses. There’s also a higher level of transparency and organization at Waves because it is more centralized.
All trades get sent through a centralized Matcher node which makes Saves more like a centralized exchange. Matcher nodes are supposed to execute trades without having access to funds to ensure a higher level of privacy and security. This is supposed to make for lower trading and transaction fees.
One big advantage to Waves is that it is easy for average people to download it and use. That makes Waves a good DEX for beginners. Waves is not regulated but its operators have retained Deloitte an international accounting firm to create a legal framework for its operations.
Many users will dislike Waves because it is based in Russia, in Moscow. There appears to be no connection between Waves and the Kremlin, but many people will distrust this DEX because of its hometown.
Unlike Waves, EtherDelta is not a centralized product or organization. Instead, it is an Ethereum-based solution that can be downloaded from GitHub.
EtherDelta is a highly professional solution that looks as if it was developed by traders for traders. Its website looks like a trader’s screen complete with an order book and a price chart.
EtherDelta is popular because it makes it easy to sell, buy and trade ICO tokens many of which are Ethereum-based. A popular use for EtherDelta is to convert ICO tokens into Ether tokens which are widely traded, bought, and sold.
Investors should probably stay away from EtherDelta if they are not trading ICOs. Cryptocurrency beginners should definitely avoid EtherDelta because it can be confusing and hard to use without a lot of Ethereum experience.
Interesting Upcoming DEX Projects
The greatest thing about blockchain and cryptocurrencies is that they are works in progress. That means there are always exciting new products and solutions under development. This extends to exchanges, there are some really cool new DEX projects are planned or underway right now.
Kyber is a relatively new decentralized exchange designed for trading and conversion of Bitcoin, Ethereum, and ICOs.
Kyber’s creators hope to make extremely accurate pricing of altcoins possible through a new mechanism called the liquid-weighted price (LWP). The hope is to base the price on liquidity so there will always be money available for trading.
Kyber offers conversions and exchanges of Bitcoin and Ether tokens through the Kyber Network. The purpose of the network is to provide a hedge against inflation and pay anybody with your token. The recipient will accept the token because he or she can use Kyber to instantly convert it into Bitcoin or Ethereum.
OX is one of the most fascinating DEX solutions yet developed because it is not an exchange. Instead, it is supposed to be a protocol for exchange between exchanges, according to cofounder Amir Bandeali.
The hope for OX is to create a mechanism that allows people to move tokens between the many different exchanges that have been created within the Ethereum ecosystem. Ethereum is actually a vast decentralized network in which a wide variety of exchanges and cryptocurrencies are operating.
The problem, which OX is supposed to solve, is that many of those Ethereum-products cannot communicate directly with each other. OX is supposed to serve as an interface that will allow you to move ICOs, Ether, and Ethereum constructs such as smart contracts and Dapps around the Ethereum system.
OX is not a solution designed for everyday users. Instead, it looks like a professional solution designed for Ethereum developers and investors that are buying and selling large amounts of ICO tokens.
OmiseGo aims to disrupt many different financial areas: money remittance, digital wallets, crypto-to-fiate conversions, and a DEX that aims to connect to their network. The exact plans of the OMG DEX is still to be determined, but the company has big ambitions in this area with their own DEX.
Who should be Using Decentralized Exchanges?
Decentralized exchanges are not for everybody. Many people including casual investors, cryptocurrency beginners, and persons that just want to make transactions in altcoins should stay away from them.
If you are not trading ICO tokens or buying large amounts of cryptocurrency there is little or no advantage to using a DEX. Likewise, people who are interested in margin trading, or currency trading would probably be better served by a centralized exchange like CEX.IO or Kraken. On the other hand, a person that needs to buy a large amount of cryptocurrency for a specific purpose might be better served with a DEX.
Anybody that uses a DEX should definitely have another method of cryptocurrency storage such as a hardware wallet or another digital wallet. Something to remember is that DEX is not based as a storage solution but as a trading mechanism.
Every investor needs to understand the difference between a DEX and a centralized exchange. Understanding how both solutions work can making trading easier and save you money.