Decentralized Crypto Exchanges
Cryptocurrencies are just like other financial assets. This means that they can also be bought and sold in financial markets. However, since they cannot be listed on regular financial markets, special markets have been created for trading them. These markets can be of two types viz. centralized and decentralized. In the previous article, we have already studied details about centralized exchanges. In this article, we will have a closer look at what decentralized crypto exchanges are and the pros and cons which they have to offer.
What are Decentralized Crypto Exchanges?
Decentralized exchanges are online platforms where users can trade cryptocurrency directly with other users. This means that the transactions happen using a peer-to-peer mechanism without having any central intermediary. The defining feature of a decentralized exchange is that crypto investors retain complete control over their funds. They do not have to hand over their funds to a centralized authority like they have to do in the case of a centralized exchange. This means that decentralized exchanges also do not act as custodians of the investors funds. Hence, they do not have any infrastructure or digital wallets to safely store the users funds.
Advantages of Decentralized Crypto Exchanges
Decentralized exchanges are quite popular amongst crypto investors. This is because they provide certain advantages. Some of these advantages have been listed below:
- More Options: An average decentralized exchange has more than 1500 different types of coins which are on offer. This is much more as compared to an average centralized exchange where only about 50 different types of coins may be offered. Hence, if investors want to buy a cryptocurrency that has not become extremely popular, they can only buy it on these decentralized exchanges.
- No-Risk of Government Intervention: There are no physical offices of a decentralized exchange. These exchanges only exist in the virtual world. Hence, they are often not registered with any government. In fact, most of these exchanges do not operate from a single location. Instead, their computer networks are spread out over many countries. Therefore, unless and until all these countries take action at the same time, these exchanges cannot be shut down. Hence, the risk of any loss from government intervention is quite less.
- Lower Transaction Fees: Decentralized exchanges are online platforms that can operate at very low costs. This is the reason that the transaction fees on these exchanges are quite low. These exchanges only have to compensate other parties who provide liquidity which is why they can afford to operate on transaction fees which are much lower as compared to centralized exchanges.
- Possession of Coins: The control and possession of coins remain with the user. Unlike, centralized exchanges, the coins are not deposited with the exchange but instead remain with the users themselves. This eliminates the chance of confiscation by the exchange or at the hands of government authorities.
- Transparent: Since decentralized exchanges are perceived to be riskier, they tend to provide more information to the investors in order to make them feel safe. This information makes the record much more transparent. Hence, educated investors, who understand how cryptocurrency works prefer decentralized exchanges because of this additional transparency offered.
- Not Regulated: Also, decentralized exchanges are not regulated. Hence, they do not need to abide by the rules and follow KYC norms. Transactions in most decentralized exchanges can be done in a completely anonymous way. The only thing required to transact in such exchanges is a digital wallet with funds in it.
Disadvantages of Decentralized Crypto Exchanges
There are several disadvantages to using decentralized cryptocurrency exchanges. Some of these disadvantages have been explained below:
- Currencies Accepted: Decentralized exchanges only accept cryptocurrency for payments. On the other hand, centralized exchanges accept fiat currencies. Hence, if an investor uses decentralized exchanges, they cannot use wire transfers and such other modes of payment that are commonly used.
- Price Manipulation: Since decentralized exchanges are operated anonymously, there is always a chance of price manipulation. In the past, prices on decentralized exchanges were found to be higher as compared to centralized exchanges. This has happened several times in the past. Decentralized exchanges are trying to get rid of this issue but have been unable to completely eradicate it until now.
- Security Issues: Since coins are not managed by the exchange but by the investors directly, there is always a chance of an attack by hackers. Hackers often try to lure investors into revealing their private keys so that their money can be stolen. Since the exchange is not in charge of security, investors have to be extra vigilant in order to avoid fraud.
- Not User-Friendly: Decentralized exchanges offer limited functionalities as compared to centralized exchanges. There are no stop-loss or limit orders available in most of these exchanges. The user interfaces they offer are also quite complex. Most novice investors have reported that they find the interfaces to be complex and overwhelming as compared to centralized exchanges where the interfaces are intuitive and easy to use.
- Liquidity: If the total transaction value in top centralized exchanges is compared with the top decentralized exchanges, then the value will be very similar. However, it needs to be understood that on average a decentralized exchange has bout 30 times as many coins as a centralized exchange. Therefore, when you consider on an individual coin level, the liquidity appears to be quite less.
The fact of the matter is that both centralized and decentralized exchanges can be used to trade cryptocurrencies. Investors should weigh the factors important to them, compare the alternatives, and then make a final decision.
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The article is Written By Prachi Juneja and Reviewed By Management Study Guide Content Team. MSG Content Team comprises experienced Faculty Member, Professionals and Subject Matter Experts. We are a ISO 2001:2015 Certified Education Provider. To Know more, click on About Us. The use of this material is free for learning and education purpose. Please reference authorship of content used, including link(s) to ManagementStudyGuide.com and the content page url.
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