One of the objectives of cryptocurrencies is decentralization. However, most cryptocurrency trading takes place on centralized exchanges. This, in effect, centralizes what is supposed to be a decentralized technology. Increasingly, we are hearing about the advantages of decentralized exchanges, or DEX as they are known. A decentralized crypto exchange allows investors to trade directly with one another, without having to entrust their funds to a third party.
Cryptocurrency enthusiasts tend to be very much in favor of decentralized exchanges and their reasoning seems sound. However, sometimes reality gets in the way of the way things “should be.”
The main advantage of decentralized exchanges is privacy and security. On a centralized exchange, a wallet is attached to an account with a name. That defeats the goal of remaining anonymous, or at the very least pseudonymous. And, as several high-profile security breaches have proven, centralized exchanges are not as secure as we would like to believe.
Several decentralized exchanges are already operational, with many more in the pipeline. Most of these exchanges can only facilitate trade on a specific blockchain. For example, Etherdelta and IDEX only allow trading in ERC-20 tokens, while Waves Dex requires one leg of any trade to be a Waves token.
Now, let’s look at centralized exchanges, and the reasons DEX may struggle to catch up. The most prominent exchanges include Coinbase, CEX, Bitfinex, and Kraken, which is reviewed over at bestbitcoinexchange.io. These exchanges are well established and earned a fortune in fees over the last 18 months, leaving them very well-funded. That gives them a distinct advantage over DEX when it comes to marketing and development.
Centralized exchanges are, for the most part, far easier to use and offer more functionality than DEX. It’s also easier to fund an account, reset your forgotten password and ask for support.
The second issue is liquidity. Anyone who has worked in the stock market will know that liquidity is everything. Capital flows to the exchanges with liquidity, and stock exchanges use all sorts of matching algorithms to increase the trading volumes they can facilitate. This is something centralized crypto exchanges do too.
Decentralized exchanges fall short when it comes to liquidity. Because they are not centralized, they cannot facilitate automatic matching of buy and sell orders. They use a variety of approaches to try to match buyers and sellers but many of these approaches have their own drawbacks. It’s estimated that 99 percent of trading volumes are already flowing through centralized exchanges, which means DEX are clearly struggling to generate trading volumes.
And, as far as security goes, there is no obligation to keep your crypto assets on an exchange. You can simply transfer them to a hardware wallet and use the exchange only when you want to trade.
When you consider that liquidity attracts liquidity and that centralized exchanges are easier to use, already established, and well-funded, you have to wonder how decentralized exchanges plan to unseat them. Yes, in theory, decentralized currencies should be traded on decentralized exchanges. However, realistically, they have a very steep hill to climb