What are decentralized exchanges (DEX)?

What is a decentralized exchange?

A decentralized exchange (DEX) is a exchange that operates on the basis of a distributed registry, does not store user funds and personal data on its servers, and acts only as a platform for searching for matches on applications for the purchase or sale of user assets. Trading on such platforms takes place directly between participants (peer-to-peer) without any financial intermediaries.

At the same time, most existing exchanges that call themselves decentralized are not really so: they use their own servers to store trading data and applications for the purchase or sale of user assets, however, private keys are stored by the users themselves.

How are decentralized exchanges different from centralized ones?

Centralized exchanges are managed by a particular company or person who are profit-oriented. Managing exchanges are responsible for protecting user data and trading information, fully control the operation of the platform and independently make decisions important for the development of the project.

Decentralized exchanges are managed automatically or semi-automatically with the involvement of platform participants in the process of making important decisions. Such platforms provide the technical possibility of direct interaction between participants and use a distributed registry (blockchain) to store and process all (or almost all) of the data.

Which decentralized exchanges are already working?

Here are a few already functioning representatives:

  • IDEX – a decentralized exchange on Ethereum with real-time trading and the ability to trade directly from a hardware wallet;
  • Waves Dex is a multi-platform decentralized exchange with the ability to exchange cryptocurrencies for fiat money from the Waves project. Project representatives argue that at the moment, trading volumes on the platform account for more than 25% of the total trading volume on all decentralized exchanges;
  • Bancor Network is a decentralized exchange with an automatic pricing mechanism and, therefore, with a lack of dispersion between the purchase and sale prices of tokens;
  • Switcheo Network is a decentralized multi-chain exchange based on the NEO blockchain with zero commissions.
    Today, there are more than two hundred fully functioning decentralized exchanges, but now it is difficult to compare this number with the number of their centralized counterparts, which, apparently, can exceed several thousand.

What are the main advantages of decentralized exchanges?

Most of the strengths of decentralized exchanges stem from their distributed architecture and the lack of a single control center. Here are a few key benefits:

decentralized exchanges ensure complete anonymity of the user;
a decentralized exchange does not store user assets, therefore neither hacker attacks nor the complete collapse of the exchange itself are threatened with a loss of funds, which radically distinguishes them from centralized exchanges that are hacked quite regularly, including such large exchanges as ShapeShift and Bitfinex;
the decentralized exchange does not have a single entry point through which it would be possible to access all assets and data, which complicates the work for crackers and makes the attack itself meaningless;
there are no personal accounts on a decentralized exchange, verification is not required, and you do not even need to specify e-mail, therefore no one will be able to use or steal personal data of users;
a decentralized exchange does not have a leadership interested in manipulating prices within the exchange;
since the exchange has a distributed architecture, authorities cannot close it or freeze your account.
Thus, decentralized platforms leave users with complete control over their funds, applications and data, and at the same time full responsibility for their actions.

What are the main disadvantages of decentralized exchanges?

The same architecture of decentralized exchanges and the complete control of users over their own funds entail a number of difficulties:

many options for traders, such as stop loss, margin trading or landing, are not available for users of most decentralized exchanges;
decentralized exchanges usually have a smaller pool of liquidity compared to centralized exchanges;
a decentralized exchange, by definition, cannot have a support service that can affect transactions or user accounts;
since many decentralized exchanges are controlled by smart contracts, cryptocurrencies that do not support interaction with smart contracts cannot trade on them.
Based on the difficulties described above, decentralized exchanges are much more reliable and safer than centralized ones, but are more suitable for experienced users who are ready to take full responsibility for their actions without the ability to contact the support service LCD and request a refund. In addition, some decentralized exchanges, such as Bancor, have vulnerabilities, as a result of which unauthorized withdrawals are also possible from them.

How are decentralized exchanges regulated?

In the US, regulators are trying to apply the existing legal framework, and in Singapore, authorities are trying to create a new regulatory framework for the operation of such exchanges. Nevertheless, there is no unequivocal position regarding decentralized exchanges in these countries, and in other countries decentralized exchanges are not regulated at all.

One of the main difficulties associated with the regulation of decentralized exchanges is that in most cases such exchanges are not controlled by specific legal entities or individuals.

This leads to problems with identifying those responsible in case of any violation, difficulties with checking trading activity and identifying possible violations. For the same reason, some already existing rules applicable to centralized exchanges cannot be applied to decentralized exchanges.

How will the concept of a decentralized exchange develop?

There is an opinion that centralized exchanges will gradually introduce the functionality of decentralized ones, and therefore the future of online exchangers lies somewhere in the middle, offering the user the advantages of both types of exchanges. In general, decentralized exchanges are considered the most successful solution for serving a wide mass of cryptocurrency users.

Nevertheless, the problems of blockchain scaling, as well as the massive use of cryptocurrency (the so-called mass adoption), remain unresolved. In addition, in order to attract more users to decentralized exchanges, first of all, it will be necessary to solve the problem of the complexity of the user interface (and some have already done this). Until all these problems are resolved, decentralized exchanges will most likely remain a purely niche product.

The card was prepared in collaboration with the Waves blockchain platform, which is developing the decentralized Waves Dex exchange.

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