With an increasing number of vulnerabilities present in Centralized exchanges, Decentralized Cryptocurrency exchanges are a lifeline to solve the security issues. It uses immutability as the information that is recorded on the blockchain network cannot be changed or modified. Hence, it ensures transparency through a trustless mechanism.
They also consist of all the basic components such as a friendly user interface, an accurate trading engine, wallets, sufficient liquidity, and a robust admin system.
Let us go deep if each of the above-mentioned components would work in a decentralized environment.
Graphical user interface – It acts as a nutshell of the entire system. It would work for different systems such as a website, mobile device, desktop application, smart TV’s, and gadgets.
Trading engine – It is crucial for handling the order management system effectively. It manages different types of orders such as limit order and market order. However, this function is better not to be decentralized as orders once made are irreversible. It can hamper the user experience if it is made decentralized.
Cryptocurrency wallets – Since hackers can attack centralized wallets, it is worth enough to be decentralized to protect user’s funds and their data.
Liquidity – The service of market-making and sharing of liquidity does not work any longer. Since decentralization gives users full control over their funds, it is not possible to use a third-party service or a liquidity pool due to the peculiarity of decentralized cryptocurrency wallets. This can be improved by establishing a hybrid cryptocurrency instead.
Admin system – It is better if the admin system is decentralized as it provides a comprehensive list of registered users, history of trades conducted on the platform, and transactions executed.
Advantages rendered by Decentralized Cryptocurrency Exchanges
Anonymity – With no compliance with KYC (Know Your Customer) and AML (Anti- Money Laundering) guidelines, absolute anonymity is ensured from the user’s side. There is no need for users to disclose their identities while trading. This ensures a higher level of transparency in the system. Hence, it proves to be a lucrative opportunity for conducting trading and exchange operations.
Scalability – It acts as a hidden benefit. The level of bandwidth provided to the users depends on the GAS that has been set for miners to execute your specific request faster. Even if the system is down for some time, it does not mean that the money is lost.
Easy to add coins or tokens – Adding new coins or tokens becomes quite simple for the users. In case, a decentralized exchange is being planned to be launched on Ethereum, then the ERC20 tokens will automatically be available instantaneously.
Better access to coins – Several different options are made available to access coins. Private keys can be imported for using wallets, integration with leading wallets such as Metamask is ensured. This will help users to go through their favourite ledgers seamlessly.
Supports numerous frameworks – Decentralized exchange platforms were built mostly on Ethereum which used smart contracts to automate processes and remove intermediaries.
Shortcomings of Decentralized Cryptocurrency exchanges
The issue of front-running – Since every order is submitted to the blockchain network for getting approval, anyone can see a transaction before it is mined. This increased visibility leaves every trade susceptible to interception as front-runners end up paying a high gas price to incentivize the network to mine their transaction first ahead of others who are patiently waiting.
The risk of trade failures – Since the blockchain network reflects the transactions only after they are mine, there are many instances when a limit order is visible on the order books as well as on the pending execution and settlement records. Users are unaware of this precarious situation. Hence, it leads to multiple attempts to fill the same order, and network-level failure is experienced for every trader.
Expensive cancellation charges – In case a user decides to cancel his order, it must be validated on-chain leading to additional expenses being incurred for the process of updating orders. This affects the market makers who incur extreme costs from constantly updating the orders on the system setting higher spreads and experiencing worse pricing.
Limitations in accessing different types of orders – A decentralized cryptocurrency exchange is capable of executing only the basic market functions. Hence, users cannot create more complex orders such as take-profit, and stop-loss orders that rely on assistance from a third party.
Despite some limitations, the advantages rendered by decentralized cryptocurrency exchanges outweigh the demerits. Centralized, decentralized, and hybrid exchanges provide users various ways to interact with cryptocurrencies and they are vastly different in several critical aspects. Hence, it is important to understand the impact of these differences, how they can affect a user, and the upcoming alternatives and advances available in the market before sending your money off.
Hence, in the era of increasing regulation and rising scrutinization of the cryptocurrency industry, a decentralized cryptocurrency exchange platform is a welcome step forward.