Most crypto trading takes place on centralised exchanges. These involve intermediaries, third parties, and authorities which are intentionally absent in any decentralized crypto exchange. A decentralised exchange (DEX) is devoid of any organisation that approves or denies your trading privileges. At their core, a DEX uses smart contracts to ensure both parties fulfil the conditions of their agreement.
A smart contract is a digital blockchain-based contract that automatically verifies and executes an agreement. In the context of a DEX, a smart contract is typically used to hold traders funds in a temporary escrow to ensure that both players uphold the terms of the trade. Smart contracts do not involve any form of human intervention making them perfectly suited for tasks that typically attract malicious activity or fraud. Using a smart contract enables a DEX to function even in the absence of intermediaries.
Since smart contracts live on a cryptocurrency network DEX’s experience virtually no downtime. The data relating to each trade is also recorded permanently on the blockchain guaranteeing absolute transparency.
The most prominent difference between decentralised and centralised exchanges is that the a DEX does not take custody of your assets, be it fiat or cryptos. For this reason, DEX’s are commonly referred to as non-custodial. This is an important distinction because centralised exchanges require you to deposit your assets with them before trading. So you are trusting the exchange to safeguard your holdings and uphold the terms of a trade.
In the event that a centralised exchange suffers a security breach, user assets are an easy target for the attacker. Dozens of exchanges have fallen victim to massive hacks and breaches over the years and although these are becoming less common they can still happen especially if the exchange is not being honest about what security measures they employ. Since crypto transactions are final in nature, an exchange can do nothing to retrieve lost or stolen funds.
A DEX does not require you to give it control of your cryptos. This means that you can continue storing them in a private wallet until the trade is finalised. In addition to the security benefits, a DEX guarantees transparency and accountability.
While the trade and order matching processes at most centralised exchanges are proprietary, the opposite is true for most decentralised ones. Uniswap, one of the most popular DEX’s is open source, meaning its code is publicly auditable. Any vulnerabilities found in the order matching process can be quickly detected by the crypto community at large and then fixed.
Centralised exchanges are structured as a company which means they need to make a profit by charging fees at almost every step such as crypto and fiat deposits and withdrawals and buy and sell orders. DEX’s keep trading fees as close to zero as possible. Uniswap, for example, claims it “functions in the public good” and does not charge a platform fee.
Like any financial institution, centralised exchanges are legally required to comply with local laws and international regulations. This is why exchanges require you to submit personal ID and even tax-related documents sometimes to sign up for an account. Collecting this information is mandatory under Know Your Customer (KYC) and Anti-Money Laundering (AML) laws. DEX’s are insulated from KYC/AML requirements.
A DEX can be accessed and used by anyone with an internet connection, anywhere in the world. The absence of a central authority or entity means that governments have no way to force a DEX to adopt user identification measures and governments are powerless to shut a DEX down. Users don’t have to do a KYC since a DEX does not hold any customer records.
A few factors may not appeal to a wide range of users. One can be the lack of liquidity at smaller DEX platforms. Since every trade is peer-to-peer, an exchange may not have enough users willing to trade what you want or at the price you want to trade at. Slow trade settlement times could also be a potential negative for DEX’s. Since trades are peer-to-peer, it can take several minutes for transfers to finalise and appear on a blockchain. But several minutes is perfectly fine for non professional traders. Innovations in the crypto and DeFi (Decentralised Finance) space will likely alleviate these issues. Until then, DEX platforms can already offer meaningful privacy and security benefits. The upsides of a DEX far outweigh the downsides.
Referenced from https://www.makeuseof.com/author/rahul-nambiampurath/
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