All cryptocurrency exchanges involve the exchange of some type of fiat currency into cryptocurrency (and vice versa). At the same time, however, cryptocurrency exchanges come in many different shapes and sizes. Some are compatible with different fiat currencies and cryptocurrencies, and others vary by language, transaction limits, or fees. But one of the most distinguishing features, decentralisation, is especially unique to blockchain projects and cryptocurrency exchanges.
Decentralised exchanges are very different from their centralised counterparts, but in order to truly understand what sets them apart, we first need to set the table and address the basics of centralised exchanges.
If you have any experience in this area, you’re probably much more familiar with centralised exchanges than decentralised ones. The most popular cryptocurrency exchanges in use today and the recent past are centralised exchanges; think Coinbase, Gemini, Kraken, Binance, etc.
Users deposit money into centralised exchanges, where the funds are held in a wallet, and wait for a trade order to complete. Users can place buy or sell orders, and these orders are matched by the exchange before funds are transferred. On a centralised exchange, each of these transactions occurs seemingly instantaneously, but there is no blockchain-based record of their occurrence; everything is kept off-chain, within the exchange itself.
Similarly, the private key for your exchange wallet is kept on the exchange, and the exchange takes control of your funds while adjusting your account balance to reflect any trades, deposits, or withdrawals. On a centralised exchange, you trust the exchange to protect your funds and accurately represent your account balance.
At its core, decentralisation is about eliminating middlemen to take more control of your assets and create more fair, community-oriented solutions. With exchanges, decentralisation can reduce transaction fees and unite willing buyers and sellers through an approach that takes power from the hands of large, for-profit entities while affording greater control to cryptocurrency traders.
Like individual cryptocurrencies, decentralised exchanges run on a blockchain. Instead of syndicating buy and sell orders to match willing buyers and sellers in a non-transparent, off-chain system, a truly decentralised exchange settles orders in a transparent, on-chain manner that enables more secure, peer-to-peer (P2P) transactions with the exchange serving as a routing layer. Trades happen directly between traders’ wallets, and the exchange never touches your crypto assets.
While it may seem like decentralised exchanges are the obvious frontrunners for our cryptocurrency trading needs, decentralised exchanges still lag behind centralised exchanges in usage and functionality. Before we get to a point of total decentralised exchange adoption, there are a few issues that need to be resolved.
One of the first hurdles to decentralised exchange adoption is usability. Decentralised exchanges are unlike anything most of us have ever used, whereas centralised exchanges provide familiar experiences with their account-based structure. Centralised exchanges aren’t much different from online banking and investing, while decentralised exchanges require users to manage their own private keys and navigate unintuitive, limited user interfaces. This means beginners and new investors are opting for centralised exchanges as they’re familiar and easier to use.
However, many cryptocurrency novices don’t fully understand the security flaws of centralised exchanges. If more attention is drawn to the risks of not holding your own private key or having full control of your funds, users might think twice about their fund management and trading habits.
However, many people may fully understand decentralised exchanges and still choose not to use them. Since they offer significantly less functionality and trade volume at this time, decentralised exchanges are not yet the right fit for many traders. Buy and sell orders are notoriously limited on these types of exchanges, so users face liquidity issues and transaction volume remains low. Interestingly enough, this is a bit of a circular problem that could be solved by more users on the exchanges, but we probably won’t see that happen until the exchanges begin to offer better interfaces and more value to their users.
As time goes on however, we expect decentralised exchanges to become more simple and clean-cut, and you can expect to see a rise in popularity. After all, cryptocurrency has been designed to be fully decentralised. While centralised exchanges may be winning today’s exchange popularity contest, decentralised exchanges are the future.
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