By now we are sure you know how Coinstop feels about storing your cryptocurrency on an exchange. When you store your assets on an exchange you are giving up ownership of your private keys, this goes against some of the fundamental principles of Bitcoin. Exchanges store the private keys on behalf of their users and instead, you are given access to your cryptocurrency via a username and password to log into their website. What happens if their website disappears? Well, so does your cryptocurrency!
But what if the exchange is decentralised?
WHAT IS A DECENTRALISED EXCHANGE?
A decentralised exchange (DEX) is a non-centralised alternative to an exchange in which no single entity is in charge of the assets. Unlike traditional centralised exchanges, decentralised exchanges are facilitated through the use of self-executing agreements written in code; also known as smart contracts.
Another notable difference to centralised exchanges, which are custodial (meaning they hold the user's private keys), is that DEXs allow users to keep their private keys private at all times. Decentralised exchanges allow users to trade directly from their wallets by interacting with the smart contracts behind the trading platform. Traders guard their funds and are responsible for losing them if they make mistakes such as losing their private keys or sending funds to the wrong addresses.
The customers' deposited funds or assets are issued an “I owe you” via decentralised exchange portals, which can be freely traded on the network. An IOU is essentially a blockchain-based token that has the same value as the underlying asset.
Popular decentralised exchanges have been built on top of leading blockchains that support smart contracts. They are built on top of layer-one protocols, meaning that they are built directly on the blockchain. The most popular and widely used DEXs are built on the Ethereum blockchain.
WHY DO WE NEED DECENTRALISED EXCHANGES?
DEXs were created so that users could trade without the need for any authority to oversee and authorise. In essence, they allow for peer-to-peer (P2P) trading of cryptocurrencies. They are non-custodial, meaning traders keep control of their wallet's private keys. A private key is what authorises and signs cryptocurrency transactions. Users can immediately access their crypto balances after logging into the DEX with their private key; they are not required to submit any personal information like names and addresses, which is great for privacy reasons.
The safe generation and storage of your private key is the MOST important thing about owning cryptocurrencies, especially when the individual now becomes the sole responsibility in this new decentralised industry. If someone else has a copy or access to your private key, they also have the ability to move your funds, which is obviously not a good thing.
Innovations that solved liquidity-related problems such as automated market makers helped attract users to the decentralised finance (DeFi) space and largely contributed to its growth. DEX aggregators and wallet extensions fueled the growth of decentralised platforms by optimising token prices, swap fees and slippage, all while offering a better rate for users.
RISK OF DECENTRALISED EXCHANGES
Smart contracts on blockchains like Ethereum are publicly available and anyone can review their code. Smart contracts of large decentralized exchanges are also audited by firms that help confirm the security of the code. This leaves a lot of room for human error, in which exploitable bugs may slip past audits and other code reviews. Auditors may even be unable to foresee potential new exploits that can cost liquidity providers their tokens.
While it may require you to put in a little extra effort to secure your crypto, it’s well worth it! Here at Coinstop, we remain committed to providing you with the latest in crypto security, so you can ensure your assets are safe. To visit our store, head here.