Decentralized exchanges (DEX) are platforms that also enable traders to buy/sell/trade cryptocurrencies. Decentralized exchanges are called as such as there is not one owner of the platform but rather the platform and its underlying infrastructure are maintained by a cadre of people. Projects such as 0x, Kyber, NEX, EtherDelta, IDEX, and Waves are examples of decentralized exchanges. Traders remain in control of their funds because they are in control of their private keys. DEXs utilize the functions of the blockchain themselves to enable more secure and transparent transactions. The most appealing aspect of a DEX is the opportunity for equal access regardless of jurisdiction, personal custodianship, and increased security. With that said, most, if not all DEXs are not purely decentralized. In fact, most of them are hybrid exchanges.
Hybrid exchanges are also listed in the table below due to the fact most DEXs have centralized components to it. Order books, for example, are hosted on centralized servers. Other features such as history records, charting, and chat boxes are also likely housed on third party servers. Like DEXs, hybrids do not hold private keys.
| Topic | Centralized | Decentralized | Hybrid |
|---|---|---|---|
| Security | Failure points: employees, servers, client terminals (employee laptops) | Centralized portions of a DEX can be compromised, such as the DNS (i.e. domain swap) | Centralized portions of a DEX can be compromised, such as the DNS (i.e. domain swap) |
| Custodian Risk | Private keys held by exchange. A minority of these exchanges enable users to own their private key | Trader owns private keys | Depends on configuration of the exchange. |
| KYC / AML | Exchanges follow accords of domicile | No KYC/AML needed. Potential risk of money laundering. | Mix and mash of both. May follow accords of domicile. |
| Transparency | Transactions not recorded onchain but on exchange's database instead | Transactions conducted via Smart Contract. Paper trail on public ledger. | Transactions conducted via Smart Contract. Paper trail on public ledger. |
| User Experience | Fast. Familiar to equity traders. | Slow. Clunky to log in. Typically lacking auto order matching. | Slow. Clunky to log in. Typically lacking auto order matching. |
| Liquidity | 99% of trading volume is on centralized exchanges | Less than 1% of trading volume | Less than 1% of trading volume |
| Dividends / Hard Forks | Not every exchange accommodates hard forks | Not every exchange accommodates hard forks | Not every exchange accommodates hard forks |
| Token Listing Process | Apply online. Relationship based at times. Fee based at times. | Tokens often listed before centralize exchanges. Apply online. Relationship based at times. Fee based at times. | Tokens often listed before centralize exchanges. Apply online. Relationship based at times. Fee based at times. |
| Fees and Withdrawals | Fees per trade and withdrawal. Limits may be placed for withdrawals. | Depends on exchange but fees per trade. May have minimum limits for withdrawals. | Depends on exchange but fees per trade. May have minimum limits for withdrawals. |
Centralized exchanges are likely to to hold sway over established markets as they increase their security and as insurance services are offered. Fast and convenient experiences will strengthen their grip over the market. Today, 99% of trades are conducted on centralized exchanges. Decentralized and Hybrid exchange face an uphill climb in offering a fast and convenient experience. While solutions are currently underway, liquidity (mentioned below) remains a huge adoption hurdle for DEXs.
Insurance
Over the long run, centralized exchanges are likely to invent or acquire insurance services with the trade fees they generate. This additional blanket of coverage will assure traders that a portion of their funds can be restored if verifiably stolen.
Transparency and Audit Trails
Transactions on decentralized are recorded onchain on the blockchain. Depending if the blockchain is public the transactions are recorded as a smart contract transaction and withdrawals from the Dex as a deposit into your onchain address. This benefits tax preparers, governments, and businesses that require a clear paper trail. Over the long run, governmental frameworks are likely to apply pressure to centralized exchanges to provide information. Given enough time, the transparency and audit trail is likely to reach parity.
Liquidity and Consolidation
The market is becoming more fragmented by the week. New exchanges are popping up due to the attractive profits existing exchanges are raking in. With the increasing numbers of exchanges, liquidity is sitting at a global level will become trapped in closed systems. The likely trends in the long term will feature:Centralized exchanges represent an evergreen honeypot for thieves. With 99% of trading volume, centralized exchanges are a tempting target. With increased fees funding operations, exchanges are likely to hire top tier talent, provide insurance benefits, and enable best in class security features. While no system is 100% secure, centralized exchanges are in stronger position than DEXs to fund security innovation.
Most crypto traders have interacted with a centralized exchange such as Binance or GDAX. Beginners often start out with Coinbase. Eventually, traders become curious and search for diamonds in the rough. DEXs are an ideal place to find these hidden gems prior to a tokens listing on a major centralized exchange. Do what works for you but educate yourself before wading into the deep end of the swimming pool.
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