What are decentralised exchanges and why are they important?

By LQDEX founders, Yogesh Srihari and Sergey Nikitin.

Decentralised exchanges don’t rely on third parties to hold traders funds. Bitcoin, the first blockchain-based cryptocurrency, was developed to allow users to transfer and trade value without relying on a third party service to hold funds or validate transactions. Instead, Bitcoin relies on anonymous miners to process transactions to ensure problems like fraud are not possible.

The mining mechanism of Bitcoin ensured privately-owned banks could not control the printing or lending of money that largely contributed to the economic crash of 2008. However, many cryptocurrency users have become detached from the primary decentralised goal of Bitcoin by trading on centralised exchanges.

Centralised exchanges

The vast majority of crypto-enthusiasts are familiar with centralised exchanges like Coinbase and Binance. These have come into popularity because of their easy-to-use, easy-to-access functionality. They reduce the friction involved in an exchange by providing liquidity (assets can be bought and sold at stable prices).

Although centralised exchanges do offer the benefits outlined above, they are full of pitfalls that the average crypto newbie may not be able to identify.

1. Trust

As previously mentioned, Bitcoin was developed to avoid third parties. Traders on centralised exchanges are required to put the same amount of trust as they do in centralised banks, like Wells Fargo.

2. Documentation

A selfie, passport or ID scan, or other personal documents may be required in order to trade on a centralised exchange.

3. Security

Centralised exchanges are vulnerable to hacking, which is why platforms like Mt. Gox, which lost hundreds of millions of dollars in user funds, have become notorious in the crypto community.

4. Fees

While most decentralised exchanges charge minor fixed fees, some are notorious for charging up to .3% in fees.

Decentralised exchanges

Unlike centralised exchanges, decentralised exchanges do not rely on a third party service to hold trader funds. Instead, trades occur in a peer-to-peer manner through an automated process. The decentralised system is typically achieved by the generation of proxy tokens.

Thus far, there has been criticism of decentralised exchanges due to shortcomings like limited functionality (no stop-loss or limit-order) and difficulty to use (lacking simple user interface).

Benefits of decentralised exchanges

1 Fast, cheap transactions

Since decentralised exchanges do not rely on a third-party authenticator, they operate quicker and cheaper than their centralised counterparts. Users on DEX will see lower fees and reduced lag time.

2 Funds controlled by users

Traders keep their private keys and investments at all times, thus maintaining control of their funds.

3 Transparent

All transactions are open for anyone to inspect or improve upon.

4 International

Since decentralised exchanges are not associated with the government, they can easily operate on an international scale.

The ideal exchange

Being decentralised is just one characteristic of the ideal exchange. Market research has found that an optimal exchange will allow trading of assets on multiple blockchains, offer substantial liquidity, have low fees, and will be high-speed.

A decentralised exchange project to watch

2018 promises to be a groundbreaking year for decentralised exchanges as crypto startups are focused at alleviating some of the issues identified within the DEX space. LQDEX, a cross-chain digital asset exchange, has published a technical whitepaper outlining a user-friendly, highly functional exchange with high liquidity.

Can CEX and DEX coexist?

The type of exchange that a trader uses largely depends on their need to weigh privacy, security and, sometimes, interface. One must consider if they feel their funds are more secure in a private wallet (likely the answer) or a centralised server. With the aforementioned considered, the market certainly has room for both types of platforms to flourish as the needs of the crypto community continuously diversify.

Decentralised exchanges – find out more

This section of our website is packed full of guides broken down into handy categories which should help you find out more information. Here are two related guides that will give you more great information on exchanges:

What’s the difference between decentralised & centralised cryptocurrency exchanges?

Which cryptocurrency exchange should I use?

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