Cryptocurrency exchanges may be familiar to you. Sign up with your email, create a secure password, and validate your account.
Decentralized exchanges are similar but don’t need registration. Crypto deposits and withdrawals are rare. Without a third party, two users trade straight from their wallets.
Decentralized exchanges may not always contain the assets you desire. These might become essential components of bitcoin as the technology and interest expand.
Defining Decentralized Exchanges
In theory, any swapping between two people could be a decentralized trade (see, for instance, Atomic Swaps Explained). But in this article, what we’re mostly interested in is a platform that acts as a centralized exchange. Their back end is on a blockchain, which is the main difference. No one holds your money, and you don’t have to trust the exchange as much as you do with centralized offerings, if at all.
A Decentralized Exchange and How it Works?
In some ways, DEXs are the same as their centralized counterparts, but in other ways, they are very different. First, it’s important to know that users can choose from a few different kinds of decentralized exchanges. All of them have in common that orders are carried out on-chain (using smart contracts) and that users never give up control of their funds.
Cross-chain decentralized exchange have been worked on, but the most popular ones focus on assets on a single blockchain (such as Ethereum or Binance Chain).
On-Chain Order Books
The On-chain order book is an important DEXs category. Within the Decentralized Exchange platform, each P2P transaction is written, recorded, and routed to the on-chain order space.
In addition, the On-chain order book technique provides approval whenever a user asks to purchase or cancel an order. It also requires miners of digital assets to confirm every transaction over the network alone.
Off-Chain Order Book
In contrast to the on-chain order book, blockchain-based transactions are mostly recorded in an off-chain order book. A centralized protocol hosts the recorded transactions, however. Thus, the off-chain order book employs “relayers” to assist with oversight.
Since the off-chain order book transactions are mostly housed on centralized institutions, there is a chance that it will also have some of the Centralized Exchanges’ security vulnerabilities. However, unlike the on-chain order book, off-chain order book transactions are not as costly.
We’ve talked about some pros of DEXs in general terms in the sections above. Let’s learn more about them.
Many exchanges follow the Know Your Customer and Anti-Money Laundering (KYC/AML) rules. For legal reasons, people often have to show proof of who they are and where they live.
Some people are worried about their privacy, and others are worried about how easy it is to get to. What if you don’t have the right papers with you? What if someone gets the information? Since you don’t need permission to use DEXs, no one checks who you are. All you need is a place to store your cryptocurrency.
But when DEXs is partly run by a central authority, they have to follow some laws. If the order book is centralized, the host sometimes has to stay compliant.
No Risk of The Other Side
Decentralized cryptocurrency exchanges are appealing because they don’t hold their customers’ money. So, even major hacks won’t put users’ money at risk or make sensitive personal information public.
Even if a token isn’t listed on a central exchange, it can still be traded freely on a decentralized exchange (DEX), as long as there are buyers and sellers.
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