Decentralized crypto exchanges enable users to buy and sell cryptocurrency without financial intermediaries, instead using smart contracts – self-executing pieces of code on the blockchain – for this transaction. They typically charge lower fees than their centralized counterparts.
This briefing, along with Part II on centralized exchanges, proposes crypto marketplace regulatory policy which recognizes these differences between decentralized exchanges and centralized exchanges. Specific proposals include narrowly tailored definitions for decentralized exchanges as well as practical pathways for registration.
Security
Decentralized exchanges offer users greater security by giving them full control of their funds, while centralized ones lack this level of oversight and may be vulnerable to hacks that result in theft of user assets.
Decentralized crypto exchanges don’t need their own team to manage user accounts and monitor transactions, thus eliminating risks associated with identity theft and fraud as well as adhering to strict Know Your Customer (KYC) and Anti-Money Laundering (AML) rules.
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Liquidity
Liquidity refers to the ease with which digital assets can be bought or sold without drastically impacting their prevailing market value. Centralized exchanges tend to offer higher liquidity due to having established client bases and offering access to various cryptocurrencies for trading.
Contrarily, DEXs use self-executing smart contracts to facilitate large-scale crypto asset transactions between users. As opposed to exchanges that store or transfer custody of user funds, DEXs utilize blockchain networks which enable a transparent view into how these mechanisms facilitate exchange.
DEXs can offer lower fees than their centralized counterparts due to not incurring the infrastructure, security and compliance costs associated with running an exchange, along with knowing your customer and anti-money laundering requirements that centralized exchanges must abide by.
Usability
Decentralized crypto exchanges (DEXs), also known as DExs, are blockchain-based apps that facilitate large-scale trading of cryptocurrency assets between multiple users. Instead of acting as financial intermediaries, DEXs use algorithms to establish prices and build liquidity pools; additionally, DEXs do not hold user funds in custodial accounts – instead users trade wallet balances directly via smart contracts on platforms like Uniswap and Sushiswap.
As opposed to their centralized counterparts, DEXs tend to be less user-friendly and take longer for transactions to complete, as well as having lower liquidity levels than traditional exchanges. Furthermore, their use can be cumbersome for novice investors.
However, as more regulatory bodies take steps to regulate crypto exchanges and usability features are expected to improve over time. Furthermore, technological developments will make crypto trading even simpler and faster, increasing user trust while improving overall usability of platforms.
Regulation
Security investments on centralized exchanges have helped reduce hacks of large magnitude, but they remain susceptible to other issues, including system failure or fraud. TerraUSD and Luna, two ETH-backed stablecoins that lost over USD 50 billion of value recently were delisted from several exchanges following losses exceeding this amount. Furthermore, users must trust centralized exchanges with their private keys that may be subject to theft or loss.
DEXs employ smart contracts residing on blockchain networks to facilitate P2P trading without an intermediary, thus helping reduce systemic centralization risks in the cryptocurrency ecosystem.
DEXs offer lower fees due to not charging commissions. However, DEXs may still face regulatory challenges such as KYC/AML requirements, security token classification requirements and complying with international regulations. It’s therefore crucial for DEXs to hire legal experts with expertise in crypto regulations across jurisdictions.
