Created in 2008 by the pseudonymous computer programmer Satoshi Nakamoto, Bitcoin is the first blockchain-based cryptocurrency. It was created as a peer to peer payment system that allows its users to transfer value with no third party or central authority involved. Since a network of distributed and mostly anonymous miners is all in charge of processing the transactions, the issues like fraud, censorship, and others are avoided.
The automated issuance mechanism of Bitcoin through mining also seeks to remove the control of money printing from banks that are privately owned and that lend money to the public and governments at an interest, creating the debt-based economy that led to the crash in 2008. This in turn led to the creation of Bitcoin. However, the primary goal of Bitcoin, to return the control of money to its owners, is in a way lost. Today, we entrust our Bitcoin with third party services daily, and the most popular of these services are exchanges.
Centralized exchanges are easy to use, easy to access and they are great for making quick trades. They also provide advanced trading functionalities like margin trading and others. However, they are also a great place for hackers to target, so they represent a security risk for your funds.
Centralized exchanges also provide a place for their users to store their cryptos. Even though it’s been said many times that using exchanges to store your cryptocurrency is not a good idea, still many people do it. This results in the popular exchanges becoming a honey pot for hackers to target, which has resulted in many people losing lots of money. Some exchanges are simply malicious or incompetent, practicing fractional reserve systems that can either lead to bankruptcy (the demise of mybitcoin), a voluntary elimination of the excess instruments (Mt. Gox hack from June 2011 or more recently Bitfinex hack), or a new investor bailout.
?Read here about top decentralized cryptocurrency exchanges.
Nevertheless, despite all these problems, we need to exchange our currencies. There are certain services and items that cannot be bought with Bitcoin (yet). That’s why, in order to acquire Bitcoin or cryptocurrencies, most people have to exchange it for a national currency. Furthermore, some cryptocurrencies like Bitshares or Ether have special tools and features that cannot be found in Bitcoin. So how to exchange coins without entrusting them to a third party service? The answer is simple. We can use decentralized exchanges.
What are Decentralized Exchanges?
Decentralized exchanges are the exchanges that do not require a third party to store your funds. Instead, you are always directly in control of your coins and you conduct transactions directly with whoever wants to purchase or sell your coins. This system can be achieved by creating assets (that can represent shares in a company for example) or proxy tokens (crypto assets that represent a certain fiat or crypto currency) or through a decentralized multi-signature escrow system, among other solutions that are currently being developed.
This system represents an alternative to the current model of centralized exchanges, where users deposit funds and get IOUs managed by the exchange. In this current model, when users ask to withdraw their funds, these are converted back into the cryptocurrency they represent and sent to their owners.
Benefits and Advantages
The most obvious benefit to using a decentralized exchange over a centralized one is that with a decentralized exchange there is no need to trust any single authority – it is a trustless service. This means that the funds are held by you in your personal wallet and not by a third party, so you are not required to trust the security or honesty of the exchange.
Another advantage to the decentralized exchanges is that they do not require you to give out your personal information. Users are not required to disclose their personal details to anyone, except if the exchange method involves bank transfers. In that case your identity is revealed only to the person that is selling or purchasing from you.
Furthermore, the hosting of decentralized exchanges is distributed through nodes. This means that with decentralized exchanges, there is no risk of server downtime.
There are more benefits beyond these:
- Transparent and Open
All code that is used for running the network and all transactions occurring on the network are open source. Also, the live software is open to anyone anywhere to inspect, copy and improve upon.
- Efficient, Fast, Global, 24/7
A decentralized exchange is global service that is available to any member of the free internet, at every corner of the globe at all times of the day. This ensures transactions and settlement within seconds. Also, there is no need for brick and mortar institutions. This means that the cost of transactions can be 10x, 100x or even 1000x less than what they are with the traditional system.
- Incorruptibly Secure
In the traditional financial system the intermediaries are centralized institutions that can be corrupted, robbed, hacked, or coerced. Single points of failure can be catastrophic with such centralized systems. On the other hand, with a decentralized exchange everyone keeps control of their own keys to their own funds.
Why Is This So Important?
Decentralized exchanges are efficient, transparent, available 24/7, fast, global and trustless, and that’s why they are so important. As the software develops it will become more user-friendly. It will offer innovative services that are difficult to imagine at this stage. With both decentralized exchanges and Bitcoin, the “internet of money” is quickly becoming a reality that will shape our future significantly.
Beyond these simple benefits and advantages, decentralized exchanges are important for deeper reasons as well, and I will highlight four reasons here:
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- No more banking cartels
Everything is now in the open for everyone to see. This means that there is no need for large institutions to keep things private. In the traditional system, big institutions like banks, corporations and hedge funds could use security as an argument to keep all your information, as well as all their information, privately locked up and backed by their authority. On the other hand, the power of this new technology allows everything to be out in the open without compromising security.
- No more identity theft
In the traditional system, we give out our credit card information, private details, and even our keys and passwords to people we do business with. Through the power of cryptography this is no longer necessary. This new technology allows everyone to keep their personal details, information, and keys secure while proving that they have the right credentials.
- A platform for innovation
With collaborative services like Wikipedia, which is many times the size of even the best lexicons, we have seen an explosion of information on topics of all kinds. In the new digital age, we need not only to bring money to the internet, but to bring the innovative power of the internet to the services that money can provide: micropayments, smart contracts, and in short “programmable money”. This will unleash the exponential growth of information-technology into the realm of global, financial services.
- Freedom for the unbanked
There is no reason any longer why the poor and unbanked should be banned from participating in the global economy. Our capitalist-minded financial services and their corrupt regimes no longer need to play an important part in their freedoms. With decentralized exchanges, anyone can store and transfer wealth at almost no cost, to anyone, anywhere in the world.
Downsides and Disadvantages
Some decentralized exchanges like Bitsquare require a user to be online in order for an order to be listed and for the trade to take place. This requires a user to perform certain actions like signaling that a payment was received.
Also, decentralized exchanges only allow the basic exchange of currency for a predetermined value, which means that trading features like margin trading, lending and stop loss are currently not available in the decentralized model.
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Furthermore, John McAfee, the technology security expert, wrote an article recently suggesting that decentralized exchanges make it more difficult to trace funds for the purpose of taxation, which could be a problem for government regulatory agencies. Maybe this is the reason why countries like South Korea and China have recently made moves to regulate cryptocurrency exchanges.
Decentralized Exchanges List
Uniswap offers a simple one-click interface to swap any two Ethereum assets against an underlying liquidity pool.
Trading with Uniswap is trustless and permissionless thanks to liquidity pools which allow anyone to create or seed a market by supplying it an equal value of the two ERC20 tokens being paired. Liquidity providers earn a pro-rata portion of the 0.3% trading fees each time the trading pair is used.
Uniswap currently does not have a native token, meaning liquidity providers earn the fees dominated in the assets within their respective market.
- Aave recently introduced a Uniswap Money Market – allowing users to post UNI LP tokens as collateral for a loan.
- Applications can seamlessly integrate a Uniswap front-end into their product
- Certain projects – like Synthetix – offer incentives for seeding liquidity on Uniswap
- Uniswap V2 allows for flash swaps
dYdX is unique as it allows users to go long or short on Ether with up to 5x leverage in a permissionless fashion. Better yet, dYdX provides cross-margin lending and borrowing, meaning users earn passive income while supported assets sit on the exchange.
- Capital supplied on dYdX collects interest even while it is being used on an active trading position.
- Users can purchase smart contract covers on dYdX using Nexus Mutual.
- dYdX offers spot markets for seamless conversion between supported assets like Dai, USDC, and ETH.
Bisq is another prominent decentralized Bitcoin exchange. It allows users to exchange Bitcoin for national currencies without having to divulge any identifying information. It is an open-source desktop application built and sustained by developers all over the world.
It leverages Tor routing, local computing, and personal wallets to ensure that no single component of the software is centralized. It should be noted, however, that trading on Bisq is significantly slower due to these characteristics. Unlike 0x Relayers, no part of a trade is centralized — including matching buyers and sellers.
Instead, Bitcoin sellers must manually search for orders in their preferred national currency and non-crypto payment method.
The convenience of placing an order also depends on which traditional payments platform users intend to use. Some Bitcoin orders are only available if users also have a Zelle account, for example. Other options include bank transfers, but this option may raise suspicions for certain financial institutions.
Regarding security, all funds and deposits made before executing a trade are held in a 2-of-2 multi-signature escrow. The security deposit needed to begin trading and prevent fraudulent behavior is 2% of the total trade. This is the closest equivalent to a trading fee in this network.
While the liquidity is low and the speed is slower than most, Bisq prides itself on having total decentralization.
Instantaneously allowing traders to automatically get the best prices on the DEX market (for ERC20 tokens) is one reason that this platform of convenience has massively grown in popularity over the last few year.
For traders investing, buying, and selling TRC-based tokens, TronTrade’s simple user interface is a great place to be.
One of the most popular and well-recommended exchanges on this list, Uniswap offers an Ethereum-based, automated, and decentralized set of services.
This Chiene EOS-based decentralized exchange offers high security from through its multi-signature smart contracts, which also enable decentralized asset custody.
Another DEX from the Ethereum family is called Airswap Protocol. Airswap does not require any identifying information for traders to begin trading, nor do they charge fees.
Indeed there are many similarities between Airswap and 0x, but examining their differences will make clear the wide variety of Ethereum-based approaches to DEXes.
Like 0x, Airswap balances certain off-chain activity for speed with other on-chain activity for security. Instead of Relayers, off-chain activity in Airswap is executed via a lightweight peer discovery engine. This engine also ensures that there is real intent to buy and sell specific assets. Each party has expressly sought out the counterparty to trade with, thus order cancellations are rare on Airswap.
Once a trading partner is established, the two parties then negotiate the price for the digital asset in question. If a price cannot be agreed upon, the parties must then query an oracle. The Airswap whitepaper explains that “the Oracle provides this pricing information to help both the Maker and the Taker make more educated pricing decisions and to smooth the process of trade negotiation.”
To prevent dishonest activity, each trade asks users to lock up an amount of Airswap tokens for a period. Only ERC-20 based tokens are eligible for trade on this platform (with the inclusion of Tether), and liquidity, at press time, is just over $12,000. It is currently backed by blockchain firm ConsenSys.
Kyber Network is a leading liquidity protocol that incentivizes Reserve Managers to contribute to an aggregated pool of liquidity for a pro-rata share of 0.3% trading fees.
Kyber’s DEX – Kyber Swap – has seen significant growth in recent months and is expected to lead as one of the top DEXs throughout 2020.
Kyber uses a native token – Kyber Network Crystals ($KNC) – for governance and a claim on trading fees.
Kyber will soon launch Katalyst – a tokenomic upgrade that introduces the KyberDAO – a means for users to govern protocol fees and earn ETH for participation.
- Kyber has an extensive ecosystem and some of the deepest liquidity pools in the DEX space
- Many notable DeFi applications user Kyber under the hood
- Kyber Reserves offer liquidity on niche assets unavailable or untradable on other DEXs
Thanks to YOLO, EOS network traders are able to get one of the smoothest token swapping experiences in the DEX market.
The final DEX on this list is a RenVM powered exchange that protects the anonymity of those looking to mint their WBTC.
The balancing act between individual user anonymity and security, government control, and protection from potential hacks and frauds, will likely continue for some time. Some countries have adopted different responses to the growing cryptocurrency industry. However, users who are concerned about digital currency theft may wish to explore their options within the decentralized services that allow users to be in charge of their money.
Decentralized exchanges provide global, frictionless value-transfers and many cryptocurrency enthusiasts think that they are the solution to the problems that Bitcoin exchanges currently pose. Without decentralized exchanges, there will always be intermediaries having control over the flow of value.
CaptainAltcoin's writers and guest post authors may or may not have a vested interest in any of the mentioned projects and businesses. None of the content on CaptainAltcoin is investment advice nor is it a replacement for advice from a certified financial planner. The views expressed in this article are those of the author and do not necessarily reflect the official policy or position of CaptainAltcoin.com