DEX Masterclass 101: Centralised exchanges vs decentralised trading
The DEX Masterclass is a series of episodes where George Harrap (Bitspark CEO) and Aaron Mangal (Editor The Latest Crypto) discuss the concepts of decentralised trading, how to trade on the DEX, advanced trading strategies, how to find unique trading opportunities and how trading on the Sparkdex works.
In the first episode, we take a deep dive into the world of traditional exchanges, and how cryptocurrency trading has created an entirely new concept: decentralised trading on the DEX.
What you’ll learn
- How traditional exchanges work
- The innovation that crypto exchanges have introduced
- The difference between centralised and decentralised exchanges
- Introduction to Sparkdex
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DEX Masterclass 101
The landscape of exchanges
In today’s trading world, we can make a distinction between centralised and decentralised exchanges. The differentiation between the two types of exchanges is a totally new concept, introduced by cryptocurrency trading.
In the traditional world of trading, think forex and stock markets, we are almost always talking about a centralised exchange: one company that has both buyers and sellers on board. For example, the New York Stock Exchange is a centralised exchange. That is a company that runs a marketplace that enables people to exchange one asset for another.
When two people trade on a traditional exchanges, they are not actually trading directly with each other. Instead, it’s the centralised exchange that is the counterparty. For example, it is the NYSE that has the US dollars and Apple shares in custody. The centralised exchange acts as the middleman that matches the requests between buyers and sellers of US dollars and Apple shares. That concept is referred to as order matching.
Taking these dynamics to crypto exchanges, the centralised exchanges like Binance act as the middlemen that provide order matching between the people trading cryptocurrency with another cryptocurrency or national fiat currency.
Having to deal with several middlemen is becoming less accepted, and while the traditional world seems committed to that model, crypto exchanges have taken it to the next level.
A closer look at centralised crypto exchanges
There are many centralised crypto exchanges such as Bitfinex, Bittrex, Poloniex and Binance which is currently the largest in terms of daily volume. Unlike traditional centralised exchanges, you can go straight to the website of any crypto exchange, sign up and start trading.
Trades are done by connecting directly to the exchange, meaning there are no more brokers or other middlemen involved other than the exchange itself as the counterparty that acts as the order matcher.
Another big difference compared to the traditional model, is that a centralised crypto exchange actually controls the order book and your funds. The centralised exchange is in charge of keeping your funds secure and protect it from hacks, which makes trusting the exchange to act as a good custodian a very important factor.
Most liquidity in the crypto market is on centralised crypto exchanges because they are generally easy to use. You don’t need to manage your keys, don’t need to learn or understand complicated wallets. All you need is an email and a password to start trading.
The downside of that is that all the funds are held in a centralised place, making it a target for exchange hacks.
How decentralised exchanges work
Decentralised exchanges (DEX) are practically the opposite of what we’ve described under centralised exchanges. They are generally less easy to use with lower liquidity, but far more superior in terms of security.
There is no counterparty at the center of a trade on the DEX, traders exchange assets directly between each other. Instead of giving the order to a middleman to make the trade at a certain price, the individual wallets of the traders talk directly to each other and exchange assets on the agreed price.
Individuals on the DEX have custody over their own funds, wallets and keys. There is no centralised authority that can stop you from trading or freeze your accounts. But if you lose access to your account or lose your keys, there is also no centralised party that can restore access.
Much like in the real world, if you leave your wallet on a park bench and walk away, you’ve simply lost your wallet.
DEXs have been around for about 5 years now, with BitShares the first DEX to come online. BitShares is a very fast exchange with tested transaction per second at 3300, with the capability to go up to 100,000. Speed is very important for exchange because prices can change very quickly, so orders need to be completed promptly in order to capitalise on market opportunities.
Next to the BitShares DEX, there are quite a few others than run on different blockchains such as Ethereum. The specific blockchain a DEX is on affects the technical side of a DEX such as which coins can be listed, who gets to decide which coins are listed, to what degree it is decentralised and if it has mining.
Introduction to Sparkdex
Created by Bitspark, Sparkdex is a gateway to the BitShares DEX. It is not a new DEX, using a new blockchain or a new construct. Instead, it’s just a different way of interacting with the already existing BitShares blockchain and DEX.
Sparkdex is essentially a window that visualises your interaction with the BitShares blockchain, and Bitspark has added things that adds value for customers. For example, Bitspark has added specific cryptocurrencies that are related to our core services such as local currency stablecoins for HKD, AUD, USD and rewards token Zeph.
However, even though Bitspark created the Sparkdex, Bitspark can’t change anything related to the blockchain, order books or executed trades. It is still a decentralised exchange. If anything were to happen to Bitspark, your keys, wallets and funds are still controlled and accessible by you.
In the next episode
Exploring the complete Bitshares DEX ecosystem and a case study on stable.PHP - a stablecoin for Philippines peso created by Bitspark.