An exchange is an organized market where tradable items are bought and sold. In the world of cryptocurrency, there are online exchange platforms where people can trade different types of cryptocurrency or fiat currency. Decentralized exchanges are what make cryptocurrency truly desirable for those that want a system that doesn’t use a third party intermediary between a buyer and a seller.
Centralized Exchanges vs. Decentralized Exchanges
The best way to understand decentralized exchanges and why they are desirable for cryptocurrency is to compare them to centralized exchanges.
Centralized Exchange: A centralized exchange like Coinbase, Mercatox, etc., centers on a third party that matches two parties that want to transact with each other. The third party holds the funds. These centralized exchange centers have many rules that each party must conform to in order to participate, such as “know your customer” regulations and anti-money laundering laws. This third party becomes the authority on the transaction and if parties don’t meet their requirements, they cannot complete the transaction.
Decentralized Exchange: Unlike a centralized exchange, a decentralized exchange like ForkDelta is a platform that is established directly between both parties. There is no third party to set up rules of trading. Instead, the trade takes place using an automated process. Because there is no central authority on a decentralized exchange, there is no storage of personal information like names or account balances, so parties can keep everything private.
A Look at the Pros and Cons of Each Exchange
There are many pros and cons when it comes to choosing which type of exchange to use. At the end of the day, it’s up to the individual user to decide. Often, it comes down to personal preference and comfort level. Often, people will use a mixture of both, because they appreciate the benefits of each.
Centralized Exchange Benefits:
- Options for recourse if someone is scammed or hacked.
- The central authority oversees daily operations like security, maintenance, growth and customer service.
- Better user experience due to the thoughtful execution of business plans.
- Easy onboarding for first-time users.
- Insurance may cover some or all losses.
Centralized Exchange Drawbacks:
- Because servers are in only a few locations, they are more vulnerable to server downtime.
- The centralized structure makes it possible for hackers to access information and currency.
- Vulnerable to hostile takeovers or corrupt governments, causing parties to lose all their privately owned currency.
- Most third parties charge some kind of transaction fee.
Decentralized Exchange Benefits:
- The exchange operates outside of any single central authority.
- Low barrier to entry, so many new tokens and coins are available that might not be list on larger centralized exchanges.
- Exchanges are hosted on servers spread around the world, instead of one location, boosting security for each party’s data and funds.
- Parties don’t have to worry about the third party’s honesty or security because the currency is held in their own personal wallet.
- Parties also don’t have to share their personal information with anyone, so privacy is high.
- Decentralization thwarts hackers.
- In many cases there are no transaction fees.
Decentralized Exchange Drawbacks:
- Many aspects of traditional trade and exchange are not available in a decentralized exchange, such as lending, stop loss, and margin trading.
- Little to no customer support.
- Less focus on ease of use, so it can be very confusing or be intimidating for first-time users.
In summary, centralized exchanges are used by those who may be new to cryptocurrency and want more centralized services. Decentralized exchanges are preferred by users with cryptocurrency trading experience who want the anonymity associated with it.