Are Decentralized Exchanges Truly Decentralized?

Whether an exchange is truly decentralized is a legitimate concern because some crypto exchange platforms claiming to be decentralized are not, since they continue to use third-party accounts as a way to hold funds during transactions. In this article we'll discuss the different levels of decentralization a crypto exchange may have.

#Are Decentralized Exchanges Truly Decentralized?

Previously, crypto traders could only exchange digital assets through trusted intermediaries, who held their funds for a specific period to allow the transaction to go through safely. Today, you can use a decentralized crypto exchange platform, which eliminates the need for an intermediary account. But the question many crypto investors ask is: Are decentralized exchanges truly decentralized?

This is a legitimate concern because some crypto exchange platforms claiming to be decentralized are not completely decentralized since they continue to use third-party accounts as a way to hold funds during transactions. But this does not mean you cannot have a truly decentralized exchange, and in this article we'll discuss the decentralization of crypto exchanges and how it works.

#Features of a Decentralized Crypto Exchange

A decentralized exchange (DEX) is a platform that allows crypto traders to sell or buy digital assets without the involvement of third parties. It is a peer-to-peer platform that uses smart contracts to facilitate direct tractions between traders. This platform, which is based on blockchain technology, gives crypto traders full control over their funds, as they can trade directly with their self-custody wallets.

Compared to traditional centralized exchanges, which use intermediaries like banks and brokers, DEXs are considered more reliable because they only involve the trader and the buyer. DEXs are also more transparent because traders can monitor their funds and track each transaction from start to finish. Buying crypto on a decentralized exchange is also considered cost-effective because you do not have to pay the intermediaries for their services.

But what separates a decentralized exchange platform from a centralized platform? Here are the main features of a DEX:

1. Non-custodial: It should not rely on a third party for transactions. Traders should be able to carry out their exchanges directly.
2. No permission required: Because a DEX is a peer-to-peer platform, you do not need permission to trade. Centralized platforms have a policy known as Know Your Customer (KYC), which requires traders to submit their verification documents before they transact.
3. Cross-chain and on-chain protocols: A DEX should have cross-chain and on-chain protocols to allow traders to send and receive both messages and tokens, and allow them to initiate other actions. An on-chain protocol enables users to manage and implement changes to the blockchain.
4. Direct trading: A truly decentralized exchange should allow direct trading of two listed digital assets.

#Degree of Decentralization

As mentioned above, some decentralized exchanges still use certain aspects that are commonly associated with centralized exchanges. For example, they may rely on a central authority to control the flow of buy and sell orders that happen; meaning they can prevent some users from placing orders. Such platforms are considered quasi-decentralized exchanges as they follow the same compliance principles the are required from centralized platforms.

Decentralized exchanges with centralized components must follow the regulatory standards followed by centralized exchanges, including the KYC principle, which does not apply to truly decentralized exchanges.

In terms of security, DEXs have a higher level of security than centralized exchanges because the funds are not stored in digital wallets within the platforms. This reduces the risk of hacking and data breaches.

Lastly, DEXs give traders complete anonymity because they do not require users to submit their personal data before carrying out transactions. They do not take users through the common identification process that involves sharing full names, personal identification details, etc.

When it comes to a truly decentralized DEX, you only need a username to sign up and get started with your trading.