In our continuing series of In Case You Missed It reruns of previous articles, on this Throwback Thursday, we return to March of 2019 for a piece by Tahigichigi on understanding DEXs in under 5 mins.
Welcome to Intro to Crypto; my 20-part series explaining blockchain and crypto in simple, granny-friendly English.
If you want to swap your British pounds for dollars, euros or yuan you can do that on exchanges like the NASDAQ. If you want to swap your bitcoin for bitcoin cash, ether or XRP, you go to an exchange like Coinbase.
You send your bitcoins to Coinbase and enter exactly how many ether you want for your Bitcoins. Coinbase checks its system for someone doing the opposite trade and pockets a small fee–0.5%-1%–for doing so.
This is how "centralised exchanges" work. Centralised exchanges like Coinbase are great because they do the following;
- Let people trade cryptocurrencies 24/7, 365 from many countries.
- Let you set up your account and start trading almost immediately.
- Make money that's often used to improve features.
But. Centralised exchanges have a few drawbacks.
When you send crypto to an exchange's wallet, they hold the private key. This gives them complete control of your funds, just like a bank. Since the spirit crypto is about taking control of your own money, this doesn't sit well with many exchange users.Honeypot
Because the keys aren't in your control, you can't protect against thieves. Keys are usually stored on a computer (or 'server') that becomes a target for hackers. Over the years, millions of bitcoins have been lost to hacks, and because you can't create new ones, once they're gone, they're gone for good.Government banning
Governments like China, Korea and Russia have banned exchanges before, forcing them to shut down or move elsewhere. Binance, one of the world's biggest exchanges out of China saw the ban coming and moved to Malta where they were welcomed with open arms. Others weren't so lucky."Down for maintenance"
Matching buyers and sellers happens on servers owned by the exchange. When exchanges update their software, they can go down for a long time. Worse still, they can tell users they're "down for maintenance" when they've been hacked and want to buy time, or they're about to disappear with everyone's money (or 'exit scam').
QuadrigaCX is a Canadian crypto exchange who's CEO died while travelling in India. Because he was the only one with the wallet keys, $100m in crypto has been locked inside the exchange ever since, with no way of returning it to its rightful owners.
Thankfully, there's an answer to some of these problems.
Enter, Decentralised Exchanges
Decentralised Exchanges (or DEXs) combine the best of both worlds. Like centralised exchanges, they run 24/7, 365 for users all over the world. Unlike centralised exchanges, they tend to run on the blockchain, meaning users stay in control of their funds and can't be hacked.
Clever Little Smart Contracts
Most DEXs today run on Smart Contracts. Since Smart Contracts are just cryptocurrency wallets with a set of rules built into them, they can't be hacked. Moreover, the rules say you can only withdraw your crypto to the wallet you sent it from.
DEXs can't be banned like centralised exchanges. This is because Smart Contracts are run by computers all over the world, meaning there's no headquarters to visit and no team to arrest.
While the website for the DEX might go down, the Smart Contract itself never goes down. And because all Smart Contracts live on the blockchain, you can check the code yourself to make sure it's legit.
Last but not least, many DEX users can stay completely anonymous. This means no signing up, logging in or identity checks, which make for a better experience. DEXs can also take a smaller fee than centralised exchanges because of fewer overheads.
The Downside of DEXs
That's not to say DEXs are without their faults, including the following;
- DEXs are relatively new so there's less people buying and selling, making it hard to quickly match the order you want. This means they lack 'liquidity'.
- Many DEXs are slower because your offer is verified, mined and broadcast all on the blockchain (as opposed to matched against a list of orders on a centralised exchange). This is kind of trading is called 'on chain'.
- Because matching and trading happens on chain, it can be more expensive. You may pay a small transaction fee to the miners every time you make a trade.
- Some DEXs have little or no customer services because there's no company necessarily behind it.
Leaders of the New School
Early DEXs like EtherDelta and 0x were created after hacks of big exchanges like Mt. Gox where hackers stole 650,000 BTC. These DEXs have been running for years but because of their limitations, new DEXs are appearing.
Waves is a DEX that runs on its own blockchain and connects to others so that users can trade tokens across multiple blockchains. Switcheo is another that lets you trade between tokens on the Ethereum and NEO blockchains.
More recently, centralised exchange giant Binance decided to launch its own DEX, which it hopes will have the liquidity and speed of traditional exchanges with the security and self-custody of DEXs. Whatever happens, it looks like DEXs are only getting more and more popular.
More quick explainers from the world of blockchain…
- The world's simplest explanation of Blockchain
- The world's simplest explanation of public & private keys
- A brief history of blockchain
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