Centralized or decentralized?by Thomas G. Marketer
As we all know, the concept of ultimate decentralization is the core idea behind blockchain technologies in general and cryptocurrencies in particular. The model of a distributed ledger residing on an infinite number of nodes provides limitless opportunities for direct P2P transactions and interactions. Paradoxically, however, nearly all major cryptocurrency exchanges on today’s market are as centralized as it gets and bear amazing semblance to their traditional real-world counterparts. The most plausible explanation for that is that alternative technologies simply didn’t exist when the market started booming, which made the community to take the short route and settle down with the cookie-cutter approach as a temporary measure.
Now that the market appears to be relatively stable in comparison with the turbulent end of 2017, a lot of projects that had been on the backburner or in early stages of development are now emerging and promising a landslide penetration into the market of cryptocurrency trading. First and foremost, we are talking about decentralized exchanges, but before we go into detail, we should take a closer look at the regular centralized exchanges that the market has plenty of today.
Centralized Crypto Exchanges in a Nutshell
Centralized cryptocurrency exchanges have been around for a good while and have already had their good and bad times, which generally helped them get over the teething problems that users faced at the early stages. Essentially, centralized exchanges are systems that mediate the trading of Bitcoin to altcoins and fiat money. With enough liquidity to support massive numbers of concurrent operations, they are indispensable for crypto to fiat conversion. And it is exactly for this reason that they have been getting a lot of attention from regulators and even national governments that want to see more control and security in the fiat turf where CEX’s have firmly set their foot. Centralized exchanges are now forced to observe KYC (Know Your Customer) and AML (Anti Money Laundering) rules to ensure transparency for regulators and security for trading parties, but these practices clearly undermine the fundamental principle of cryptocurrency trading, which is anonymity.
Some of the best known CEX’s are Binance, KuCoin, BitMex, Coinbase, GDAX, Gemini, Bittrex, Bitstamp, HitBTC, Coinone, Poloniex, CEX.IO, and Kraken.
The Case of Decentralization
Decentralized cryptocurrency exchanges, or DEX’s, are the market’s response to the shortcomings of centralized exchanges (to be covered below in this article). As the name suggests, these exchanges do not sit on a particular central server or set of servers but strive to get as many of their essential components as possible to work on the chain and be truly distributed. You read it right, not all of the exchanges that claim to be fully decentralized are 100% so. Some of them, like EtherDelta or 0xProject, are innovative hybrid CEX/DEX systems where some of the data, like orders, is stored off-chain, although in a very secure state. Other projects, existing and emerging, aim at full decentralization and full on-chain operation. No matter the architecture of a particular decentralized exchange, DEX’s in general are a huge leap ahead from centralized exchanges in terms of providing a totally different level of anonymity, security, cost of transaction and speed of trading.
Some of the most promising decentralized exchanges are OpenLedger DEX, Cryptobridge DEX, Oasis DEX, Barter DEX, Bisq, Waves DEX, and IDEX.
The Pros and Cons of Existing Approaches
DEX’s and CEX’s are very different in nearly every aspect, except for their primary purpose – aiding users in exchanging various coins. Let’s take a look at the advantages and shortcomings of each model.
Security and Anonymity
Centralized exchanges have failed their users many a time. They’ve been hacked with devastating consequences (just search for Mt. Gox, Bitfinex, Bitstamp, Poloniex hacks – and that’s just the tip of the iceberg) and they’ve gone down for a long time, taking their users to the brink of having a heart attack (see the case of Kraken’s recent 40-hour maintenance). The key problem here is that centralized exchanges require your private key to perform exchange operations, and your funds actually go INTO the exchange that you work with and remain there until the actual exchange of funds has taken place. All of this means that once you’ve entrusted your money to an exchange, you no longer have control over anything. In case the exchange is compromised, you may lose all you have. This is a major risk and a major concern among the crypto public.
In addition, some types of operations on CEX’s require user identification to comply with KYC and AML regulations, which effectively takes anonymity off the table.
DEX’s are fully anonymous, don’t store any user data (let alone private keys or funds), use the P2P model and do not reveal the user’s identity. Yes, they don’t do fiat, but offer ultimate security for those who need quick and risk-free crypto-to-crypto conversion.
Decentralized exchanges are the clear winner in this round.
Liquidity is what centralized exchanges have in plenty. You will hardly have any problems exchanging any amount of X into Y with thousands and thousands of traders willing to do the same. Decentralized exchanges, on the opposite, may experience liquidity issues due to the comparatively lower number of users. This is a known problem and DEX developers are working on solutions, such as the creation of joint pools of orders that would dramatically increase the amount of crypto available for exchange.
This said, centralized exchanges are way ahead of the competition in this areaю
Cost of transactions
Centralized exchanges act as escrow accounts between buyers and sellers and charge a hefty commission on trade operations. DEX’s, on the other hand, take the intermediary out of the equation by providing a highly secure peer-to-peer trading environment where operations are performed using smart contracts and the so-called atomic swaps. No keys or funds are handed over to a third party facilitating the trading process, therefore there is no need for a large fee. Decentralized exchanges have very modest fees compared with any of their centralized counterparts. Although fees may not be the biggest showstopper for those individuals who exchange crypto once in a blue moon, they certainly are for regular traders.
Ease of use
User friendliness or, rather, the lack thereof, is one of the major concerns among those trying to use DEX’s. These exchanges are still in the early days, so their focus in on the backend side of things for now. Their UI’s may be confusing and not suitable for crypto trading rookies. They are not as intuitive as CEX’s and generally require that the user know a few things about blockchain technologies, cryptocurrencies and such, which limits their TA to the more professional public.
We’ve already mentioned that CEX’s are a breeze to use compared with DEX’s. However, they are also more functional in that they support both crypto and fiat exchange, while their decentralized counterparts allow crypto to crypto conversion only.
The Future of Crypto Trading
Throughout 2018 and beyond, we will see a steady growth of the number of decentralized exchanges. This process will run in parallel with their further refinement, growth of the user base, and dramatic shifts towards better usability. As the architecture of today's DEX's becomes truly decentralized (no elements remaining off the chain), CEX's may find themselves serving fiat to crypto operations only. However, no matter how this competition ends, the future of cryptocurrency exchanges looks unquestionably bright.
Created on Dec 26th 2018 07:50. Viewed 313 times.