Watch Out Decentralized Cryptocurrency Exchanges Are Here to Stay

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With recent changes in regulation as well as customer sentiment rapidly shifting, it’s no surprise that cryptocurrency exchanges are embracing changes within this constantly fluctuating industry.

It’s important to note that there are only a few key players that handle the overwhelming bulk of crypto trading volume.

crypto-exchanges-traded-in-volume

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There are 3 types of cryptocurrency exchange groups. Custodial, noncustodial, and decentralized exchanges (also known as DEXs).

Custodial Exchanges

centralized-exchanges-cryptocurrencyCustodial exchanges are those that act as a crypto wallet managers. They maintain user assets through an internal ledger. Customers therefore don’t have direct access to their wallets that the exchange holds for them. Only when the user decides to transfer his currency does he have a resemblance of control.

An example of these exchanges would be Coinbase, Bitfinex, Gemini, Bittrex, Bitfinex, etc. These are, by nature, centralized exchanges. An overwhelming number of trading volume (73%) runs through these custodial exchanges.

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One of the most notable advantages of using these exchanges is the ease of use at which they come with. Nonetheless, this still provokes concern over the exchanges centralized nature. With hackers breaching their internal systems and attaining private keys to the exchanges, a user’s funds can be lost overnight.

It’s worth noting that more exchanges these days have been proactively taking measures to store funds in “cold storage” (storage without connection to the Internet) which provides an extra layer of security. However, what happened with the infamous Mt. Gox, Bitfinex, and recent CoinCheck hacks still have users weary when it comes to storing large amounts of cryptocurrency on their chosen exchange.

These types of exchanges also face a major concern over price manipulation as reflected in the recent probe by the US Department of Justice.

centralized-and-decentralized-exchanges

Overview

Pros: easy to use interface, instant fiat to cryptocurrency conversion, customer support

Cons: lack of privacy, high fees, and major target for hackers.

Most of these concerns over the custodial exchanges have prompted many users to push for more decentralized exchanges.

 

Non-Custodial Exchanges

non-custodial-exchanges-centralizedThese exchanges, although still centralized, do not manage user wallets. They simply match orders through an internal order book and then take a fee on top for providing their services.

Some of the more popular noncustodial exchanges are Changelly and ShapeShift. The more popular exchange of the 2,  Shapeshift, roughly takes in around 15,000 orders a day and averages around $10-$15 million in transaction volume.

The exchange’s internal mechanics are still not transparent, which is why they are still considered centralized. Foul play is still possible within these exchanges. Also worth noting, non-custodial exchanges tend to have low liquidity which scares away more sophisticated investors.

Decentralized Exchanges

decentralized-exchanges-reviewedLast but not least, we have the decentralized exchanges, also known as DEXs. Many within the crypto community are rooting for their success. After all, isn’t the whole appeal behind cryptocurrency the idea of having a decentralized currency as well as a platform that no single party controls?

If that’s the case why do centralized platforms control so much of our crypto assets? On paper, decentralized exchanges are the perfect solution for concerns raised over centralized exchanges. They are extremely light in fees (if there are any fees at all), they are transparent in nature, and are highly secure as they allow you to control your own wallet.

There are several DEXs which execute orders under smart contracts. The chart below lists some of the current players in the space including companies that are building protocols around decentralized exchanges.

There are a few downsides to decentralized exchanges in their current state. Many of these downsides mimic the challenges of non-custodial exchanges.

  • Low liquidity
  • No inter-chain trading (like ETC to ETH)
  • Inability to convert from fiat to cryptocurrency

Hybrid Exchanges – The Best of Both Worlds

hybrid-crypto-exchanges

Many within the crypto community agree that decentralized exchanges will take a more prominent role in the future. Megan Hernbroth, Head of Communications for Coinbase, stated that the decentralized exchanges are “very important to the ecosystem of cryptocurrency trading by acting as a middle ground”.

Also note, custodial exchanges play a major role in the future of crypto trading as they offer more convenience for the casual trader. Many enthusiasts believe that the future of crypto will contain more of a hybrid approach in which both centralized and decentralized exchanges are combined. These newly developed hybrids will utilize the benefits of both exchanges.

It’s inevitable that decentralized exchanges will continue to rise in popularity. With that said, it’s highly doubtful that they match the scale and popularity of custodial exchanges anytime soon. If the awareness of security and privacy continues to grow, we may witness the birth of these “hybrid solutions”.

With regulation concerns looming over the industry, presently those within the crypto community should not entirely comfortable with storing or trading their cryptocurrency with one particular exchange.

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