Bitcoin, the first blockchain-based cryptocurrency, was created as a peer-to-peer payment system that allows its users to transfer value with no central authority or third party involved. Since a network of distributed and mostly anonymous miners are all in charge of processing the transactions, users are ensured that problems like censorship, fraud, and others are not possible.
The automated issuance mechanism of bitcoin through mining also seeks to remove the control of money issuance from privately owned banks. Privately owned banks lend money to governments at interest, creating the debt-based economy that led, among other things, to the global financial crash of 2008 - events which themselves precipitated the creation of Bitcoin.
In this context, the primary goal of Bitcoin is to return the control of money to its owners, but we entrust our bitcoin to third-party services regularly. The most popular of these services are exchanges.
Centralized exchanges are easy to use, easy to access and they provide advanced trading functionalities like margin trading among others.
They also, however, represent a security risk for your funds. While some exchanges are better guarded than others, hacks are not at all uncommon in the cryptocurrency industry, and some such as the infamous Bitfinex hack have led to thousands of users losing their savings.
Some exchanges are simply incompetent or malicious, employing fractional reserve systems that can either lead to a voluntary elimination of the excess instruments (Mt. Gox hack from June 2011), bankruptcy (the demise of mybitcoin) or a new investor bailout. The Mt. Gox case had such an impact on the Bitcoin community that it created the term "Getting Goxed".
Nevertheless, users need to exchange their cryptoassets. There are certain items and services that we cannot buy with Bitcoin (yet) and in order to acquire bitcoin or other cryptocurrencies, most people have to exchange them for a national fiat currency. Furthermore, some cryptoassets such as Ether (ETH) or Monero (XMR) have special features or tools that bitcoin doesn't offer. So how can we exchange our coins without entrusting them to a third party service? The answer lies with decentralized exchanges (or DEXs).
What is a Decentralized Exchange?
A decentralized exchange is an exchange market that does not rely on a third-party service to hold the customer's funds. Instead, trades occur directly between users (peer-to-peer) through an automated process. Such a system can be established by creating proxy tokens (cryptoassets that represent a certain fiat or cryptocurrency) or assets (that can represent shares in a company for example) or through a decentralized multi-signature escrow system, among other solutions.
This system contrasts with the centralized model in which users deposit their funds and the exchange issues an 'IOU' that can be freely traded on the platform. When a user asks to withdraw his funds, these are converted back into the cryptocurrency they represent and sent to their owner.
Benefits of DEXs
The most obvious benefit to using a decentralized exchange over a centralized one is their "trustless" nature. You are not required to trust the security or honesty of the exchange since the funds are held by you in your personal wallet and not by a third party.
Another advantage to the decentralized model is the privacy it provides. Users are not required to disclose their personal details to anyone, except if the exchange method involves bank transfers, in which case your identity is revealed only to the person that is selling or buying from you.
Furthermore, the hosting of decentralized exchanges is distributed throughout the nodes involved - meaning that there is no risk of server downtime.
Of course, there is always a downside and this case is no exception. Centralized exchanges are extremely popular for many reasons.
Some decentralized exchanges such as Bisq, require users to be online in order for an order to be listed and for the trade to take place, requiring users to perform certain actions like signaling that a payment was received.
Trading features like margin trading, lending and stop loss are currently not available on many DEXs as they only allow the basic exchange of currency for a predetermined value.
Compare Decentralized Exchanges
For more information on the latest DEXs, and a comprehensive overview of decentralized and centralized exchanges see our page here.