Decentralized Exchanges - Why Should I Use Them?

Author: 
Oke E.
Date: 
October 18, 2018
Read time: 
8 minutes
DEX
Blockchain Security

For an industry that preaches privacy, security, and decentralization, a decentralized exchange should be the go-to place for crypto trades. Today, however, an estimated 90% of crypto trades occur on centralized platforms like Poloniex and Bittrex.

Ironic, isn’t it?

Cryptocurrency trading needs a revolution and decentralized exchanges will play a major role in that important change.

DEXs - decentralized exchanges - differ from their centralized counterparts (the current top cryptocurrency exchanges) in that they don’t hold user funds. In short, decentralized exchanges facilitate trades in a peer-to-peer manner via a distributed ledger, and ensure blockchain security by utilizing smart contracts to execute the whole process.

For an industry that preaches privacy, security, and decentralization, a decentralized exchange should be the go-to place for crypto trades. Today, however, an estimated 90% of crypto trades occur on centralized platforms like Poloniex and Bittrex.

Ironic, isn’t it?

Cryptocurrency trading needs a revolution and decentralized exchanges will play a major role in that important change.

DEXs - decentralized exchanges - differ from their centralized counterparts (the current top cryptocurrency exchanges) in that they don’t hold user funds. In short, decentralized exchanges facilitate trades in a peer-to-peer manner via a distributed ledger, and ensure blockchain security by utilizing smart contracts to execute the whole process.

How does a decentralized exchange operate?

Decentralized exchanges usually have different operational models. In an ideal decentralized exchange, a user (called the Maker) submits a buy or sell order and other users (Takers) fill the order.

Here’s a brief summary of the process:

  1. Maker visits DEX, connects his/her wallet and creates a new order. Maker specifies the token, the amount, if it’s a buy or a sell order, etc. For example, “sell 250 TOK for 2 ETH.”
  2. Maker creates a cryptographic hash of the order and signs it with their private key.
  3. Maker sends the order to the blockchain and includes their signature.
  4. A Taker spots the order, trades against it, adds his/her own signature, and everything is sent to the smart contracts.
  5. The smart contracts verify that the order originates from Maker and is not expired or filled already.
  6. After verification, funds are transferred and fees are taken.

Most decentralized exchanges operate in this manner although they use slightly different smart contracts and technologies.

How decentralized exchanges operate

Benefits decentralized exchanges offer over top cryptocurrency exchanges

Using decentralized exchanges brings users numerous benefits that top cryptocurrency exchanges cannot offer. What are these benefits, exactly? Why do people use decentralized exchanges?  
 

Blockchain Security

Decentralized exchanges are more secure than top cryptocurrency exchanges because they don’t have central points of attack. These platforms don’t hold user funds in custodial accounts. Instead, you send your coins to a smart contract which matches your orders with other users and the process is executed on a distributed ledger.

The inherent blockchain security, coupled with the absence of custodial accounts, makes the typical decentralized exchange unhackable. In addition, they are mostly hosted on different servers scattered around the globe, so they rarely have down times.  
 

Increased privacy

Apart from offering blockchain security, DEXs provide greater privacy than most centralized top cryptocurrency exchanges. Whereas centralized top cryptocurrency exchanges require submission of some personal information to trade (sometimes a government-issued ID), a decentralized exchange won’t even ask for your email address

You can trade anonymously on decentralized exchanges without risking the leakage of your personal information or details of your transactions to the public or unwanted entities.
 

Not restricted by governments bans

Because they are decentralized by design, a typical decentralized exchange cannot be affected by government bans or censorship. It is extremely hard for an authority to clamp down on an exchange that exists solely on the internet and doesn’t have a physical location.
 

Full control over your coins

DEXs are unlike top cryptocurrency exchanges that require that you to make a deposit into their custodial account before you can trade; on decentralized exchanges, you are always in full control of your coins. When executing an order, you send your coins to a smart contract (instead of a custodial account) which has blockchain security.

Since you’re always in control of your funds, it’s less likely that you will be robbed of your coins when you use a decentralized exchange.

Benifit of DEX's

The average decentralized exchange doesn’t support fiat, cutting off a substantial amount of newbies who wish to buy cryptos with their Dollars and Yen.

Limitations of decentralized exchanges

Despite offering blockchain security and increased privacy, decentralized exchanges are not without some limitations. These limitations are the reasons many turn a blind eye to the flaws of top cryptocurrency exchanges and use them to buy and sell crypto. What are these issues?
 

Not user-friendly

The most common problem with decentralized exchanges is that they aren’t as user-friendly as top cryptocurrency exchanges. DEXs’ interfaces are quite complex. Crypto newbies, amateurs, and even tech-savvy individuals get easily confused and intimidated. Most times, users need to undergo a steep learning curve before they master the terrain of DEXs.
 

Arbitrage issues

To ensure blockchain security in part, matching of orders on DEXs are not automatic. This makes them vulnerable to arbitrage, which can deter honest traders. Since orders typically take a while to be filled, arbitrageurs can capitulate on the price volatility of cryptos to get really sweet, but undeserved deals - at the detriment of the Maker. To make things worse, Makers need to send a transaction to cancel the order but arbitrageurs can counter this by paying a high fee so that the trade can be mined before the order is canceled. 
 

Low liquidity and slow trade execution

Furthermore, DEXs face liquidity issues because they don’t see high volumes of usage; the majority of trades happen on top cryptocurrency exchanges. Also, trades on DEXs are relatively slow since the process takes place on blockchains, which aren’t as fast as the servers of top cryptocurrency exchanges.
 

No fiat support

In addition to these worries, the average decentralized exchange doesn’t support fiat, cutting off a substantial amount of newbies who wish to buy cryptos with their Dollars and Yen, but anonymously. DEXs also lack some advanced trading features found on their centralized counterparts. Margin trading and limit orders are absent on decentralized exchanges since trades are executed in a peer-to-peer manner. 

limitations of DEX's

Top decentralized exchanges and how they are faring

Despite sharing the same goals and ideas, decentralized exchanges utilize slightly different operational models. Some of them have some degree of centralization. These DEXs will centralize some aspects of their operations in an effort to offset the limitations repelling crypto users from them.  Let’s examine 3 popular decentralized exchanges, how decentralized they are, and what they are doing to overcome the drawbacks faced by DEXs.
 

Etherdelta

Launched a couple of years ago by respected Ethereum developers, this decentralized exchange caters solely to peer-to-peer trades of ERC-20 tokens like Iconomi, Augur and, Komodo. Etherdelta is quite popular and was the go-to place for experienced crypto traders who needed to get their hands on freshly minted tokens - that is until the website came under a phishing attack in December 2017.  

Although the platform can be seen as centralized in some instances, it is more decentralized than most DEXs since it promotes blockchain security by having a choice to keep order books on-chain. However, it experiences slow order processing and slow order cancellations.  

In terms of liquidity, Etherdelta is up there with Bancor and 0x. According to Ethereum analytics firm Alethio, the platform sees approximately 9000 trades every 10 days and offers more than 500 trading pairs.

Etherdelta’s unfriendly User Interface

One drawback with Etherdelta, apart from its tardiness, is its compact interface. Navigating the terrain is cumbersome for cryptocurrency newbies. And don’t even think about accessing it with a mobile phone; you’ll only get migraines - even if you are a pro. Here are a few tips for a better experience on Etherdelta:

  • Ensure you’re accessing the correct web address
  • Double and triple check your orders for errors; pay special attention to the prices.
  • Use a calculator if needed, don’t do all the math in your head.
  • Don’t use up all your ETH for the exchange, leave some ether for gas
  • Increase gas price if the transaction is taking too long
  • If you’re getting “no private key” or “insufficient balance” errors, click on “Reset Cache” from the upper right menu
  • Clear your browser cache too, it helps.

Ether delta

With some perseverance, you will find Etherdelta less confusing and intimidating. In time you will get the hang of it. Practice, they say, makes perfect.
 

0x protocol

This decentralized exchange is an improvement on Etherdelta in that it is a protocol from which people can build their own decentralized exchanges. It’s a community of several DEXs (like Etherdelta) called “Relayers.” Each Relayer has its own UI, which is better and more user-friendly than Etherdelta’s. Some of them even have a quick video to introduce their decentralized exchange to you and show you how to make trades using it.

This system of Relayers ushers in lots of liquidity for 0x. Radar Relay, the most prominent Relayer on the platform sees over $770k traded weekly while ERC dex, the second most prominent Relayer, has a weekly trade volume of about $100k.

0x ensures blockchain security to an extent - although Relayers make use of centralized order books, the settlement of orders is decentralized since it is done on the Ethereum blockchain using smart contracts. Furthermore, 0x and Etherdelta only allow trading of Ethereum tokens, which restricts access to other cryptocurrencies.
 

Kyber Network

Kyber Network is relatively new in the decentralized exchange space. It is designed to offer exchanges between Ether and Ethereum tokens, with the hopes of doing same for Bitcoin and other cryptocurrencies in the future. Like 0x and Etherdelta, it is big on blockchain security. With KyberNetwork, each transaction is broadcasted to the blockchain as opposed to an on-chain off-chain combination, making it really decentralized.

In addition, Kyber Network is one of the decentralized exchanges trying to tackle liquidity problems faced by its peers head on. It introduced a Dynamic Reserve Pool to provide liquidity in its ecosystem. Any individual can be a Reserve Manager, offering their haul of cryptocurrencies to provide liquidity for trades and profiting when transaction fees are paid.

Khyber network

Source: cryptospaceguides.com
 

Of the DEXs mentioned in this piece, Kyber Network has the most friendly UI. It has basic features beginners will find less intimidating. However, this decentralized exchange is yet to gain full recognition in the sphere, probably because it offers only 45 trading pairs and is a newcomer. The platform sees about 1,500 trades every 10 days but is used by an average of 500 people in that period.

 

How can decentralized exchanges shape the future of cryptocurrencies?
 

Despite battling a number of difficulties decentralized exchanges are still the most secure way to trade cryptocurrencies. A fully decentralized crypto industry can only be envisioned if DEXs are included in the big picture, and top cryptocurrency exchanges are aware of this fact. The advantages, in the future, will be too obvious for the masses to ignore. That’s why Binance is launching a decentralized exchange in 2019 and Coinbase recently acquired Paradex.

However, to become mainstream, decentralized exchanges’ core technology needs to improve. People will fully embrace blockchain security if it doesn’t mean slow trades. Luckily, new ideas are touted every day to make trading on DEXs faster and less intimidating for users. In addition, there’s a cogent need for crypto traders - newbies and experienced users alike - to improve their knowledge about how decentralized exchanges work. Of course, understanding cryptocurrency, in general, is important, too

If more people are knowledgeable about cryptocurrencies and DEXs, more people will use them, and then maybe corporate centralized exchanges- who are often hacked, charge outrageous fees, and are subject to censorship, will be overthrown. That won’t be possible, though, if you fold your hands and refuse to seek knowledge. To get better results, check out this succinct curation of cryptocurrencies which also includes the most popular DEXs- Kyber Network and 0x. Doing so will help you become better educated and make better investment decisions.

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