decentralized exchanges

People can now trade cryptocurrencies on hundreds of exchanges across the globe. But these exchanges come in many flavors. Some are decentralized, some centralized, and many are in between. Find out what the differences are and what it takes to have truly decentralized exchanges.

Before we discuss the different types of exchanges, it’s important to understand the difference between cryptocurrencies and “regular” money. So let’s first review what sets apart cryptocurrencies from fiat currencies like the US dollar:

What is a centralized currency?

A centralized currency is what you now consider money – or fiat. As its central authority, the government issues and regulates fiat money. Another central authority manages and further controls it – a bank. The bank in turn uses various intermediaries and 3rd parties when conducting the business of holding your money.

You’ve heard of a ledger before. In a bank, they have many ledgers that must balance out regularly, such as for operating expenses and customer transactions. It’s basically how they keep track of all the numbers and actions in their business. But with a bank, that ledger is centralized in a number of ways:

  • There’s one centralized server on which those ledgers reside.
  • To access the ledger, all the employees must connect to this one server when conducting business. Additionally, customers may access certain parts of the ledger to engage in online banking.
  • The Bank’s Board of Directors and executive management governs the server.
  • Some of the customer account data that goes onto the bank’s ledgers is later sold to 3rd parties. This benefits both the banks and those affiliated enterprises seeking new customers (i.e. life insurance companies).
  • Bank ledgers usually operate within one geographical region.

Vulnerabilities of Centralized Currencies

This centralization opens up traditional currencies (like the Euro or the Dollar) to the following vulnerabilities:

  • Single point of failure. If a hacker or embezzler wants to steal a bank’s money (aka the money belonging to all account holders), they have only one server to try and gain access to.
  • Control is always in the hands of a few. Decisions come without any system of consensus from the people who use and depend on this currency.
  • Since everything resides on that one server (or sometimes with international banks there are several), if the server goes down, so goes the entire system. All the employees and customers must switch to a temporary system, causing inconvenience and inefficiencies. Customers that normally access their financial information from their mobile apps or pc’s will have to wait until the system is back up.

What a decentralized currency looks like

Now let’s look and see how cryptocurrency differs from the money we use today:

  • The ledgers are distributed amongst numerous servers across the globe. That’s where the term “distributed ledgers” originated. One type of distributed ledger is a “blockchain. It’s particularly difficult to hack or manipulate a currency with the built in cryptographic and consensus functions.
  • Anyone with an internet connection, electricity and a device can access their currency. Anywhere, anytime. This includes those people in developing countries who don’t yet have access to banks, and also those unable to come up with a minimum balance to open an account.
  • The servers, which are spread broadly, are ‘ruled’ by consensus mechanisms, or algorithms that keep the currency running fairly, to benefit all users. No one server, miner, country or bank runs the show. It runs itself. It’s a community type of currency, where all the users participate and benefit.

What is stored on the blockchain

  • Only transactional data is stored on the blockchain. Your personal data is not required to own cryptocurrency. For some people, such as refugees who may have lost their official identification, they can still download a cryptocurrency wallet and transact with digital assets. It’s possible even for a family member on a distant continent to make an immediate transfer of cryptocurrency into that refugee’s wallet. Another use case is for people who regularly send part of the salary back to their family in their home country. Using crypto in this case would enable families from the poorest regions of the world to get more money, since remittance fees are notoriously exorbiant and exploitative.
  • With cryptocurrency, not only can you make a transaction almost immediately, the cost is minimal and it doesn’t matter where you are or what time it is. You can quickly send crypto to someone in the next room, or on the other side of the world. There are no boundaries or borders.
  • Only you have your “account numbers” which are referred to as private keys (or seed phrases). Unless you decide to give that information out, you are the only one with access to your cryptocurrency. We’re not just talking about keeping transactions quiet for money laundering; this is for people who believe in the right to financial privacy and financial sovereignty.

Cryptocurrencies provide a decentralized currency for everyone. Rich or poor, young or old, Canadian or Nigerian, a decentralized currency brings control back to all the people, while adding better security and increased efficiency. Move over banks!

What is a decentralized exchange?

A decentralized exchange is an online trading venue where people can buy, sell and trade digital assets. It has no centralized authority and enables peer-to-peer transactions in a secure and private fashion.

The challenge decentralized exchanges face

So far everything sounds great. You have a cryptocurrency that you can use, peer to peer, wallet to wallet, anytime and anywhere. But there’s a problem…

Blockchain technology is just getting started. Right now, MOST people are using the same old traditional currencies. Most stores, online or otherwise, do not take crypto. You most likely can’t pay your landlord with Bitcoin, and you certainly can’t make a big purchase like a home or car with crypto, unless:


You trade your crypto for fiat.

So far, we’ve talked about transactions that go directly from one person’s wallet straight to another’s. Essentially, a wallet to wallet crypto transfer happens with no intermediaries, no corresponding costs or fees, and without a wait. That is truly the beauty of crypto.

But until everybody is on board with using cryptocurrencies, we have to find ways to still use both decentralized and centralized currencies.

This is where cryptocurrency exchanges come in. Most crypto exchanges want to be decentralized because they recognize the importance. But right now, it’s extremely difficult to have completely decentralized exchanges because:

  • Until mass adoption of cryptocurrency takes place, you need a way to connect your crypto to your bank account.
  • Whenever you are dealing with banks, you must comply with their full set of centralized policies and regulations.

If you want to spend some of your crypto, there are only a few places where you can do so directly. Otherwise, for all your purchases, bills and other expenditures, you’ve got to have a traditional currency like the dollar.

The varying levels of decentralization

The many crypto exchanges that are now operating internationally actually have varying levels of decentralization. Some are even considered hybrids, a cross between centralized and decentralized. Overall, the more centralized an exchange is, the more vulnerable it is to the manipulation, control and inferior security of fiat currencies.

But a true decentralized exchange has no central authoritative entity. No one person or company is controlling it; instead, it runs on consensus algorithms using smart contracts to handle peer to peer payments.


When using a decentralized exchange you can do the following:

  • Make buys, sells and trades of major cryptocurrencies and altcoins, in privacy and safety.
  • Know that you own your money. Your digital assets, as long as you hold the keys, is yours. No central authority can manipulate, garnish, steal or forcefully tax that money.
  • You can quickly and cheaply initiate and complete a crypto transaction. This could be with someone on another continent, or the girl next to you on the subway. It doesn’t matter where you are, nor if the transaction is for .00005 BTC or 50 BTC. That transaction is between the two of you, happens almost immediately and costs barely anything.
  • Your coins are safe. Digital assets run on distributed systems that incentivize users to be good actors and keep the system running. Though there is no central authority figure, the algorithmic protocol and consensus mechanisms that involve all users keep it running. Layers of encryption make trading cryptocurrencies more secure than bank transactions.

Decentralized exchanges cannot provide governments or other central authorities with user information upon request, even if they wanted to or were required to by law. They don’t require identifying data from their users (unless those users want to transact in fiat there), and thus it is not stored anywhere.

So why isn’t everybody using decentralized exchanges?

It’s early 2019 at this time of writing, and cryptocurrencies are only in their infancy stage. As of now, most people depend on centralized fiat currencies to manage their finances. For those wanting to invest in cryptos, they need a system that allows them to use their fiat money to buy and cash in their cryptocurrencies.

To do so on a crypto exchange, most people are subject to KYC (Know your Customer) and AML (Anti-money laundering) policies. But once that happens, you are out of decentralized territory.

People can trade crypto to crypto using dozens if not hundreds of wallets and exchanges that are available. But when we talk about using fiat in any way, centralization creeps back. As more infrastructure and new innovations emerge in the blockchain space, we get closer to bringing global adoption of cryptocurrencies. Only then will we see the surge of businesses begin taking cryptocurrencies directly.

Coinbase – A wannabe dex?

A good example of a centralized cryptocurrency exchange is Coinbase. At the current time, US investors (and many others) can only use fiat money to purchase or make trades with Coinbase if they go through the complete (and bank-derived) KYC/AML procedures.

Coinbase holds your cryptographic keys as well. So one central entity is holding all the account information and the actual digital assets. Similar to a bank, only Coinbase states that they have a very secure system of cold storage. But there’s still a single point of failure. This means in the case of a hypothetical hack at Coinbase that all users are vulnerable.

In an nutshell, if you don’t own the keys to your wallets, you don’t own that crypto. Nor to you reap the benefits of decentralization.

The Introduction of Paradex

Midway through 2018, Coinbase acquired a decentralized exchange called Paradex. As of yet, it is only available in “read only” view to this American crypto writer. Because decentralization means a fair, open system that is distributed widely and secured on a user level with cryptographic keys, Coinbase fails these tests and is not decentralized.

Why are so many still people using Coinbase?

While Coinbase may look and act a lot like a traditional bank, many users simply feel they don’t have a choice but to use it. Especially if they want to cash out some crypto or use fiat to buy some more. Those that shun centralized exchanges have to get creative to buy more crypto. For example, one way would be to buy crypto from an ATM, but the exchange rates may be higher (~5-10%) than with a centralized exchange.

Another reason people have turned to Coinbase is because they were one of the first platforms to offer an ecommerce solution for crypto. Businesses using the service can take payments in crypto. And to give them credit, their user interface makes it easy to navigate and understand the process of trading cryptocurrencies. The commercial interface is simple to use as well. On top of that, they’ve been the only platform for about a year at this writing that enables investors to set up recurring buys.

Decentralized exchanges today

Just as there are varying levels of regulations across the globe, there are different levels of decentralization.
Even the most decentralized exchanges have some elements of centralization, depending on what you need to do and where you reside.

WAVES

On the Waves Decentralized Exchange (Waves DEX), it’s decentralized even if you are from the US or Canada, meaning once you have a Waves wallet, you can trade crypto to crypto.

But if you are from those countries, you are simply not eligible to trade, buy or sell in fiat currencies. One way you can spend your dollars on Waves is to pay someone you know in an eligible country, and they can purchase the crypto you want and send it right to your Waves wallet. Without the fiat function, for instance, Americans basically must get crypto sent directly into the wallet to get started and don’t have the option to buy or sell anything with fiat.

But you can use this decentralized exchange to trade cryptos in this way without going through the KYC process. As a result, Waves does not hold any of your personal information. Unless of course you want to deal in fiat, then, as you can see in the “Fiat Gateway” image below, you are required to identify yourself.

In summary, on decentralized exchanges, if you can get someone to send crypto directly to your wallet, then you can use that exchange in full decentral mode to trade, buy and sell crypto. It is only when users need to cash in their digital assets for fiat that they lose some of the benefits of decentralization.

IDEX

Idex is another example of a decentralized exchange, but it services primarily Ethereum-based cryptocurrencies, like HedgeTrade’s token, HEDG.

When you create your cryptocurrency wallet on IDEX to start trading, you’ll find a reminder like the one above. A major decentralized aspect to crypto exchanges is that you hold your account keys and the password for encrypting your keys. If you lose them, there is no account recovery, because that would entail a 3rd party holding that information. And there isn’t one. On decentralized exchanges like Waves and IDEX, there is no such intermediary.

On the other hand, if you used fiat to purchase some cryptocurrency, that bank and any of their intermediaries will keep that information on centralized servers. Later, they may allow 3rd party agencies to access parts of that data.

Conclusion

We hope this has helped you gain an understanding of decentralized exchanges and how they are operating in the current market. At HedgeTrade, we’re developing our own tokenized application that will bring many of the same benefits of decentralization discussed here to the world of trade predictions and social trading.

By using blockchain technology, we’re creating a more fair system of trading. One without costly intermediaries and with a higher level of trust and security. Join us today to hear all the latest developments on our project!


Also published on Medium.