Decentralized assets (cryptocurrencies) have a major chunk of transactions being traded on centralized exchange platforms. The cryptocurrency was created for financial disruption: the elimination of all intermediaries and mediators. The premise of cryptocurrency exchange development is also that there is no need to place one’s confidence in centralized authority. Then why are all the most common cryptocurrency exchanges centralized?
In certain aspects, a centralized exchange platform constitutes a move backward in terms of serving the aim of several cryptocurrencies, which is decentralization. The future of DeFi with regards to cryptographic assets appears firmly targeted at completing peer-to-peer transfers. It is similar to how DeFi considers its future of traditional finance without financial institutions as stewards of financial instruments.
However, consumers see their money in the hands of private individuals. They are in direct charge of the accounts in which the money of a customer is stored. As a result, consumer advantages (depending on exchange platforms) involve better trading & transaction user interfaces, liquidity systems to guarantee trading opportunities, fiat-to-crypto (and vice versa) transfer capabilities, and insurance in the event of fund loss due to hacking.
Operating on a centralized exchange implies paying the expense of accessibility. Centralized exchanges can keep the liquidity flowing using fees (transfer percentages & flat prices). Those new to cryptocurrencies, and even most cryptocurrency enthusiasts, tend to be drawn to the usability of regulated exchanges. Yet these exchanges do have challenges and vulnerabilities of their own.
For example, a level of trust in the central authority is necessary for utility. The private keys to the accounts where the savings are kept are not owned by you in a centralized exchange. There is a plethora of sensitive knowledge you have to submit. All funds are owned by a single party. It makes them vulnerable, due to a single point of weakness, in the case of hacks. Financial regulations over an exchange platform can lead to complete prohibitions on government interventions. Also, there will be a need to deal with no accountability in the organizational workings of the central authority.
Centralized exchanges might not, nor should they, go away from the mainstream shortly. Indeed, they have useful services that enable the masses to accept cryptocurrencies in general.
However, at Oodles, our DeFi development experts expect to see the emergence of replacements that fit with the initial cryptocurrency narrative; alternatives that think decentralized resources warrant decentralized markets.
In traditional finance, the typical DeFi cases include the existing financial sector. We are thoroughly informed about its applications and pressure points, after all. DeFi proposes the involvement of no intermediaries, fewer charges, and fewer unreasonable rule-based exemptions. We can describe the variations between centralized exchanges and decentralized exchanges (or DEXes) in a similar manner.
A DEX offers transaction facilitation essentially by automating trading processes, not interference. Using a DEX, apart from a password, does not require any central authority to take care of your funds, and also no personal information is needed. Core principles of most DEXes involve pseudonymity and user protection, and no central body entrusting users’ personal information. A decentralized exchange establishes a trustless network that enables users to only associate with one party. It can be the contract you trade with or the person you trade with. Smart contracts facilitate transactions with atomic swaps. It means that no deposits or withdrawals are made. For certain coins, there is no omission. It expands the range of trading opportunities. Nodes are scattered around the world to monitor the protocol. It decreases the likelihood of a hack and eliminates single-point government oversight. The absence of intermediaries means the individual maintains control of the properties (and the obligations that come with them).
Then, why does the exchange of transactions on decentralized platforms account for only 1 percent of all cryptocurrency exchanges, given some exponential growth in the DEX usage recently?
The explanation for this can be an inefficient user interface. It results in a lack of acceptance as well as a lack of assets for enhancement and liquidity assets. Ultimately, it hinders scalability and highlights the technological shortcomings of DEXes. Account termination is irreversible and solely a user’s fault. There are fewer resources available to address this challenge. Also, poor liquidity is another concern. As more users deal on the DEX than expected, the scalability challenges get worsened. It leads to clogging the network and transaction times with increased fees (if there are any) and other alarming side effects.
We must first maintain the strengths of basics for DEXes to solve their scalability issues and prosper. It requires selecting the correct blockchain platform on which the DEX runs.
Each blockchain comes with its advantages and limitations. Any exchange must select carefully upon which framework their venture is developed. For example, the technical requirements of a DEX Network should be designed from the beginning as a framework for decentralization. It must have frameworks that not only minimize scalability burden but also match up to stringent security requirements.
Privacy-preserving technology may be the most distinctive feature. It helps developers, while still being useful for end-users, to enable the execution of transactions that respect privacy principles. It also makes it easier to adhere to securities laws with the underlying trustless protocol powered by blockchain.
With the use of cryptographic primitives such as zero-knowledge proofs * and promises, blockchain will include a protocol that retains consumer confidentiality. The above-mentioned protocol function helps users to finalize trades without exposing their identity or sharing numbers. User protection is not only important from the viewpoint of an individual trader but also a prerequisite for stock trading exchanges.
The blockchain protocol, in addition to preserving the identity of individual traders, provides another significant advantage to trading on the market. When a user loses their private key and/or login credentials, present-day DEXes have no means of recovery. It is a problem that seriously hampers widespread acceptance. However, those means are given by a blockchain solution, since this is yet another prerequisite for stock trading.
The increasing size of the market for DEXes demonstrates that, as compared to a central system, there is and would be, a huge benefit put into using a trustless protocol. Not only will this need for (and growth in) a trustless environment be seen in Decentralized Cryptocurrency Exchanges, but the increasing Security Token Exchange industry will inevitably follow it.
As only one percent of all cryptocurrency transactions are accounted for by decentralized crypto exchange platforms, the overall market size of the cryptocurrency market dwindles compared to the current financial market. It has a cumulative market capitalization of listed firms that is twenty times greater than the entire cryptocurrency market when we look at Euronext for comparison. It is a single stock exchange provider in Europe. It shows that the best of decentralized finance and exchange is yet to come.