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The ultimate guide to decentralised exchanges
What are decentralised cryptocurrency exchanges, how do they work and why should you care?
Estimated reading time: 2 min
Due to the potential for losses, the Financial Conduct Authority (FCA) considers this investment to be high risk.
What are the key risks?
1. You could lose all the money you invest
- The performance of most cryptoassets can be highly volatile, with their value dropping as quickly as it can rise. You should be prepared to lose all the money you invest in cryptoassets.
- The cryptoasset market is largely unregulated. There is a risk of losing money or any cryptoassets you purchase due to risks such as cyber-attacks, financial crime and firm failure.
2. You should not expect to be protected if something goes wrong
- The Financial Services Compensation Scheme (FSCS) doesn't protect this type of investment because it's not a 'specified investment' under the UK regulatory regime – in other words, this type of investment isn't recognised as the sort of investment that the FSCS can protect. Learn more by using the FSCS investment protection checker.
- The Financial Ombudsman Service (FOS) will not be able to consider complaints related to this firm or Protection from the Financial Ombudsman Service (FOS) does not cover poor investment performance. If you have a complaint against an FCA regulated firm, FOS may be able to consider it. Learn more about FOS protection here.
3. You may not be able to sell your investment when you want to
- There is no guarantee that investments in cryptoassets can be easily sold at any given time. The ability to sell a cryptoasset depends on various factors, including the supply and demand in the market at that time.
- Operational failings such as technology outages, cyber-attacks and comingling of funds could cause unwanted delay and you may be unable to sell your cryptoassets at the time you want.
4. Cryptoasset investments can be complex
- Investments in cryptoassets can be complex, making it difficult to understand the risks associated with the investment.
- You should do your own research before investing. If something sounds too good to be true, it probably is.
5. Don't put all your eggs in one basket
- Putting all your money into a single type of investment is risky. Spreading your money across different investments makes you less dependent on any one to do well.
- A good rule of thumb is not to invest more than 10% of your money in high-risk investments.
If you are interested in learning more about how to protect yourself, visit the FCA's website here.
For further information about cryptoassets, visit the FCA's website here.
Are you worried about having your cryptocurrency stolen from a centralised exchange? You’re not alone.
From Mt. Gox and Bitfinex to Coincheck and Bitgrail, there have been many well-publicised examples of exchanges being hacked and millions of dollars’ worth of crypto being stolen. But now there’s another way to trade digital currency without entrusting your coins or tokens to a third-party exchange: decentralised exchanges.
Offering peer-to-peer trading and allowing users to retain control of their coins, decentralised exchanges offer a key security advantage over conventional platforms. As a result, they’re experiencing rapid growth at the moment, with several platforms already live and many more in development.
Below we explain how they work and what makes them so important. Our goal is to provide you with the information you need so that you can decide if decentralised exchanges offer the experience that’s right for you.
What is a decentralised exchange?
A decentralised exchange is a platform that cuts out the middleman and allows users to trade cryptocurrency directly with one another. This allows traders to retain control of their funds at all times rather than having to entrust them to an exchange provider, with trades executed using smart contracts.
Sometimes known as DEXs, decentralised exchanges offer a viable alternative for any crypto buyer who doesn’t want to trust a third-party with their funds. You can find the details of some leading DEXs and the features they offer in the table below.
DEXs are hosted on a network of distributed nodes, which not only reduces the risk of hacking but also solves the problem of server downtime that restricts users’ ability to trade. DEXs are designed to offer an open and transparent network that makes crypto trading accessible to everyone.
There are several decentralised exchanges that are already live and offering peer-to-peer trading across a range of cryptos. However, this number is expected to increase dramatically in 2018 with a host of new platforms slated to launch.
How is a DEX different from a centralised exchange?
Centralised exchanges are also online platforms where you can buy or sell digital currency, but unlike DEXs they require the use of a third party to complete transactions. Both buyers and sellers trust this middleman, the centralised exchange, to hold their assets. This requires the buyer and seller to trust the exchange to safely complete their transactions and securely store their funds.
Known for being easy to use, centralised exchanges allow you to purchase digital currency using fiat or cryptocurrencies. They provide a simple and straightforward entry point to the market and currently account for the vast majority of crypto trading around the world.
For a quick rundown of the key differences between centralised and decentralised exchanges, check out the table below.
|Conducted through the exchange
|Control of funds
|Exchange controls your coins and tokens
|You control your coins and tokens
|Prone to hacks?
|Subject to government interference?
|Account withdrawal limits?
What benefits do decentralised exchanges offer?
The key advantage of decentralised exchanges is that they allow for trustless transactions. Rather than surrendering your funds to an exchange and putting your faith in it to complete transactions as promised and responsibly manage your funds, you retain complete control.
On a centralised exchange, even once you’ve purchased crypto coins, you don’t actually own them – the coins are still owned by the exchange until you withdraw them to your personal wallet. On a decentralised exchange, you control your funds at all times and can trade coins and tokens in a peer-to-peer setting.
In fact, it could be argued that centralised exchanges go against one of the core principles of cryptocurrency. One of the key features of blockchain technology is its ability to remove the need for centralised control, while it’s also worth pointing out that most cryptocurrencies are billed as being decentralised. In such an environment, buying and selling digital currency on a centralised exchange seems somewhat counter-intuitive.
There are several other advantages to the DEX approach. The distributed nature of the network substantially reduces the risks of hacking and server downtime, while DEXs also offer minimal fees compared to centralised platforms. Decentralised exchanges also allow users to maintain their privacy and trade without disclosing all their personal details.
Pros and cons of decentralised exchanges
- You retain control of your funds
- You don’t have to trust a third party to safely manage your coins and tokens
- DEXs provide increased privacy to traders
- No risk of server downtime causing you to miss a trading opportunity
- Lower trading fees than centralised exchanges
- The introduction of atomic swaps will allow DEXs to offer faster and more efficient trading
- Lets you avoid transaction and withdrawal limits typically imposed by centralised exchanges
- Their decentralised nature reduces the risk of government regulation or crackdowns
- Not always as easy to use as conventional exchanges
- Can be intimidating and confusing for new users
- Many don’t yet provide as many advanced trading tools as centralised exchanges
- Currently don’t offer as much liquidity as centralised exchanges
- Some platforms offer limited customer support
- Lack of regulation may concern some users
What to consider when choosing a decentralised exchange
Decentralised exchanges vary quite a bit in terms of their user-friendliness, fees, customer assistance and even the digital currencies they support. With this in mind, you’ll need to thoroughly compare the features of a range of DEXs before deciding on the right platform for your needs. Factors you should consider include:
- Ease of use. DEXs often have a steep learning curve and can be difficult for newbies to understand. Take a look at each exchange’s trading interface to see how easy it will be to use.
- Security features. Check for any additional security features the platform offers to help protect your funds. For example, some platforms allow you to directly link your hardware wallet to the trading contract.
- Currencies available. Which coins and tokens can you trade on the platform? Are all your desired currencies supported, and how/when are new coins and tokens listed?
- Trading volume. How much trading volume does the platform currently maintain? Is there enough liquidity to support your trading needs?
- Transaction fees. Check the fine print for details of the platform’s trading fees and any other charges that may apply to transactions.
- Signup process. How quick and easy is it to register for an account? What details do you need to provide?
- User reviews. One way to get a better feel for the quality of an exchange is to check out some independent reviews. This will help you find out what sort of experience other users have had on the platform and whether they’ve had any problems or concerns.
By considering these factors and comparing the features of a range of platforms, you should be able to find a decentralised exchange that’s right for your needs. And if you want to buy or sell cryptocurrency without exposing yourself to the security risks associated with a centralised platform, it’s a task well worth doing.
Disclosure: At the time of writing, the author holds IOTA and XLM.
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