Beginners, traders and cryptocurrency first timers may have early exposure to crypto from buying their first Bitcoin from major names like Binance, Bitfinex or local crypto exchanges with local currencies. These major names that you may be familiar with are dubbed ‘Centralized Exchanges’ or CEX for short, whereby these exchanges are operated by an entity that offer various services and become the medium of any activity that occurred on their platform. All activities usually require fees.
Indeed these CEX offers the easiest and most convenient access to begin trading, yet after a while, when one digs deeper, they may start to start to look for alternatives for their crypto activity, especially after realizing some flaws in the Centralized Exchanges or experience bad services and even hacks.
Not Your Keys Not Your Coins
Centralized Exchanges do have flaws, and for seasoned traders that have been in the industry for long they all know all too well not to trust CEX. Here are some of the most common reasons that the trust toward CEX is dwindling :
- Not your keys, not your coins.
This is a jargon from crypto veterans suggesting simply that that CEX owns the access towards your coins. The private keys for your wallet are in their custody and obviously if anything happens to it, there is nothing that can be done. One of the worst examples of this was the MT Gox hack in 2014. They were one of the biggest bitcoin exchanges at that time, yet this accident still happened.
2. Risk of Exchanges going bankrupt.
CEX is only as good as it’s management. When there’s mismanagement or if anything were to happen to the entities that oversee the CEX, bankruptcy could occur, leaving users with very little options to recover their funds. The latest example is Cryptopia.
3. Risk of market manipulation.
When you trade on CEX, you are basically going into someone else’s house, with their rules. They can pump and dump any coins at any moment, trigger stop loss hunts, disable trading on volatile hours and many other ways to manipulate the market. Check out this publication to learn more.
Knowing all these risks, seasoned crypto traders understand that the counterpart of Centralized Exchanges, is the Decentralized Exchange, which is a methodology to mitigate these risks or even avoid these issues altogether. But how is that possible?
The Revolution Will Not Be Centralized
Decentralized Exchanges or DEX are open-source trading platforms that operate on the blockchain, where no single entity controls the flow of data. All trading transactions occur directly between users in a Peer-to-Peer (P2P) network through an automated, ‘trustless’ system. All made possible through blockchain technology that in its core ‘trustless’ and can operate with little to no human intervention.
In short, traders can trade between each other without middlemen, and with fees that are usually pre-set automatically to be sent towards the original developers or ingrained on transfer fees of the blockchain network.
As illustrated by Ivan on Tech on the following chart :
With DEX Model, traders can rest easy knowing that all the risks are all transferred toward the user, with no single point of failure. Ultimately and most importantly is the key towards the trader’s wallet is controlled by the traders themselves.
DEX is an excellent alternative that might as well be the norm of the crypto industry in 2021 and beyond. But at the moment, there are some flaws that hampers the growth of this industry and prevent first time traders to choose DEX, namely :
- Lack of Liquidity.
In CEX, the entities controlling the exchange have the resources to become or hire market makers to provide liquidity. But in most DEX, this is not the case, hence orders making can be difficult, especially when there needs to be a fill or when the trading pairs are not moving at all for days for minor tokens. In 2020, this issue was getting more spotlight in the wake of DEFI and became the focus of the developers to incentivize users who provide liquidity to DEX. Check out Uniswap.org to see how this problem is getting addressed.
2. Lack of Services
Obviously there is minimal human intervention in DEX, so if anything goes wrong, there are difficulties that can occur as there is no one to reach out to for help. Normally it’s either a decentralized team, community governance, or an organization that runs or builds the DEX that often manages the deops. Also most DEX do not offer varieties of features like CEX does, namely Savings, Margin Trading, Strategy Analysis and more due to either lack of operational incentives or resources to upkeep these services
3. Difficult User Interface.
This has been the main issue that is plaguing DEX since it’s inception. To use DEX, people have to learn how to create a wallet, connect it to the platform, sometimes one has to install the platform first on a computer, and other technical hurdles that turn off many first time traders who just wanted to start buying their first bitcoin.
For that matter, in Part 2 of this series we will explain how to use DEX and trade on select platforms to help first time traders familiarize themselves with this excellent and unique innovation of the blockchain industry.
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