Decentralized exchanges are slowly challenging the established hierarchy of top-heavy centralized cryptocurrency exchanges. It seems like a natural fit. Cryptocurrencies are, almost by definition, decentralized to a greater or lesser degree due to their use of a distributed ledger. Yet truly decentralized exchanges have been slow to catch on with the market at large.
Centralized exchanges are basically transplants from more traditional securities markets. The most immediate analog is the stock exchange. In this model, a large, centrally located business operates under strict government regulation to facilitate the buying and selling of various financial instruments. Control is a key concept here. The exchange has to keep many moving pieces together and functioning as expected, all while juggling the needs of individual investors and regulatory oversight. It means that a cryptocurrency exchange often cannot give individual investors the private keys to their currency, which could potentially offer backdoors for hackers or other malicious actors.
Spreading the wealth
A decentralized exchange, by contrast, operates under a completely different model. Control is virtually nonexistent, outside of the basic rules the platform uses to operate day to day. Instead of acting like a giant switch or gate, a decentralized exchange functions more like a matchmaking service. Individual investors retain their private keys and execute deals directly peer to peer, instead of through a liquidity pool.
This is more in keeping with the cryptocurrency ethos spelled out by Satoshi Nakamoto in the original Bitcoin whitepaper. Ideally, cryptocurrency should not rely on a trusted third party – not even an exchange – in order to facilitate its use across national and artificial financial borders.
Why, then, have decentralized exchanges faced such a steep road to general adoption?
Road to adoption
Cryptocurrency is a difficult enough concept to master. Extending that difficulty to buying and selling coins can be a little overwhelming for the average investor. So, centralized exchanges that ape traditional stock exchanges enjoyed first-mover status in the early days of the market.
The second, and related, big hurdle is the user interface. The user interface for a typical exchange is slick and easy. There is a table of available coins, a buy/sell window, and maybe some general market information. The user interface for a decentralized exchange has to get into the nitty-gritty of which users are offering which coins and at what price. Up until now, it’s been very much an inside market for buyers and sellers who are already experienced in peer-to-peer interfaces. That’s changing, slowly but surely. Surprisingly, among the big movers in this space are well-known centralized exchanges, which aim to produce decentralized platforms that are just as user-friendly. Binance and Coinbase are to add decentralized platforms to their extant offerings any time soon.
The last big challenge is security. One of the greatest selling points of cryptocurrency is that each investor is able to act as his or her own bank. Ironically, this is also one of cryptocurrency’s greatest weaknesses. Literally centuries of trust have been bred into the financial community regarding banks and other big institutions, and taking on all of the responsibility of safeguarding and storing your own wealth can be a bit too much right out of the gate.
However, with improved user interfaces and more general adoption, decentralized exchanges look poised to take their rightful place as the most appropriate way to trade cryptocurrencies.