The Evolutionary Path of Exchanges: Traditional, Centralized and then Decentralized Exchanges

In the modern trading environment, we can make a distinction between centralized and decentralized exchanges. These two types of exchanges are completely new concepts pioneered by cryptocurrency trading.

The Evolutionary Path of Exchanges: Traditional, Centralized and then Decentralized Exchanges

In the modern trading environment, we can make a distinction between centralized and decentralized exchanges. These two types of exchanges are completely new concepts pioneered by cryptocurrency trading.

But before we dive into the differences between these two types of cryptocurrency exchanges, let’s take a quick look back at traditional exchanges so we can really appreciate the evolution of how we trade our assets.

How traditional exchanges work
In the traditional trading world, such as the forex and stock markets, we are almost always talking about a centralized exchange: a company that has both buyers and sellers. For example, the New York Stock Exchange is a centralized exchange – he operates a marketplace in the form of a company that enables people to exchange one asset for another.

For example, when two people want to exchange dollars for Apple stock, they need a place to meet in order to exchange the two assets. The best way for them to meet is through an exchange that maintains transparency of all the different prices so that everyone can see what the exchange rate is for exchanging dollars for Apple stock. This is essentially what all traditional centralized exchanges are used for, such as the New York Stock Exchange, NASDAQ, Dow Jones and the Hong Kong Stock Exchange.

While there is a general perception that traditional exchanges like NASDAQ run smoothly, the reality of the layered inefficiencies beneath the surface actually paints a different picture.

When two people trade on one of these exchanges, they are not actually trading directly with each other. Instead, it is the centralized exchange that is the trading party. For example, it is the New York Stock Exchange that hosts the U.S. dollar and Apple stock. The centralized exchange acts as an intermediary, brokering requests between buyers and sellers of U.S. dollars and Apple stock. This concept is known as order aggregation.

But this does not mean that anyone can go to the Nasdaq website and register to trade. Nor is there a NASDAQ bank account to send money to. Instead, individual traders need to go through a brokerage that connects directly to the exchange (for example, a trading app like eToro). This is several layers of intermediaries at both ends of the trading spectrum, just for a simple trade.

But there is more.

Brokers use different accounts from different banks to settle with each other and with centralized exchanges. As another intermediary layer, banks multiply this inefficiency. They have no incentive to make transactions faster because it is profitable for the banks themselves to hold more money.

In fact, most of the world’s traditional exchanges use a T+2 model, which means it actually takes two days to settle. Even if your trading application says “order completed”, the reality behind it is that the trade will not settle until 2 days later. Considering the size of the industry, this means that billions of dollars are held in banks every day, waiting to be settled.

Overall, the whole process seems out of step with the way things work today, where everyone is used to downloading a mobile app and immediately starting to use a service. Traditional exchanges are not even open 24 hours a day, which means that if something big happens over the weekend, the market can’t react until Monday morning.

Having to deal with a few middlemen is becoming less and less acceptable, and while the traditional world seems committed to this model, cryptocurrency exchanges have made huge improvements to the way we trade assets.

The working model of a centralized cryptocurrency exchange
There are hundreds of cryptocurrency exchanges around the world, including AAX, Binance, Coinbase, Kraken, FTX, BitMEX, and more. Unlike traditional centralized exchanges, you can go directly to the website of any of these cryptocurrency exchanges, sign up and start trading. Trading is done directly connected to the exchange, which means there are no more brokers or other intermediaries involved other than the exchange itself as a counterparty to the order aggregator.

Another big difference compared to the traditional model is that centralized cryptocurrency exchanges actually control the order book and your funds. The centralized exchange is responsible for keeping your money safe and protecting it from hackers, which makes trusting the exchange as a good custodian a very important factor.

Cryptocurrency centralized exchanges are fast, but not as fast as traditional exchanges. This has a lot to do with the total number of customers they serve and where they are located. A traditional exchange actually serves only a limited number of customers – a handful of brokers with access – and its servers are installed right next to the exchange. In contrast, a cryptocurrency exchange needs to serve anyone with a computer anywhere in the world.

Most of the liquidity in the cryptocurrency market is on centralized cryptocurrency exchanges because they are usually easy to use. You don’t need to manage your keys, learn or understand complex wallets. All you need is an email and a password to start trading. The downside to this is that all the money is stored in one centralized place, making it a target for exchange hacks – there have been quite a few examples of this in the past.

Decentralized exchanges (DEXs) are the next stage in the evolution of trading and are designed to provide a more secure trading environment and many other benefits.

How decentralized exchanges work
DEXs are the opposite of centralized exchanges; DEXs provide a trading ecosystem that closely mirrors the cryptocurrency community’s core values around personal empowerment, decentralization, and financial sovereignty.

In general, cryptocurrency exchanges have three basic functions: money management, order books, and cryptocurrency trading. In order for an exchange to be truly decentralized, each of these functions must operate in a decentralized manner.

The user’s funds are not entrusted to a third party. Users are the custodians of their own funds and their assets are kept in their own hot and cold wallets.

Orders must be broadcast directly from one trader to another, with their application compiling the order book, without relying on some central order book service.

As the user’s application communicates to set up the trading process, orders are matched directly between traders and then broadcast over the inter-chain network for direct peer-to-peer settlement.

DEX works in a distributed fashion, with cryptocurrency transactions occurring directly between traders on a peer-to-peer basis, settling on the blockchain. This means that instead of a single centralized institution, users rely on multiple independent nodes connected to the exchange to facilitate transactions.

DEXs are the opposite of centralized exchanges.DEXs provide an ecosystem of transactions that closely reflect the cryptocurrency community’s core values around personal empowerment, decentralization, and financial sovereignty.

In general, cryptocurrency exchanges have three basic functions: funds management, order books, and cryptocurrency trading. In order for an exchange to be truly decentralized, each of these functions must operate in a decentralized manner.

Users’ funds are not entrusted to a third party. Users are the custodians of their funds and therefore keep their assets in their own hot and cold wallets.

Orders must be broadcast directly from one trader to another, with their application compiling the order book, without relying on some central order book service.

As the user’s application communicates to set up the trading process, orders are matched directly between traders and then broadcast over the inter-chain network for direct peer-to-peer settlement.

DEX works in a distributed fashion, with cryptocurrency transactions occurring directly between traders on a peer-to-peer basis, settling on the blockchain. This means that instead of a single centralized institution, users rely on multiple independent nodes connected to the exchange to facilitate transactions.

Because transactions on DEX are direct between counterparties, DEX does not hold each investor’s funds in an exchange-owned wallet. individuals on DEX have custody of their own funds, wallets, and keys. There is no centralized authority that can block your transactions or freeze your account. However, if you lose access to your account or lose your keys, there is also no centralized institution that can restore access. Just like in the real world, if you leave your wallet on a park bench and walk away, you just lost your wallet.

In the early days, trading on DEX had some serious drawbacks: slow transactions, low liquidity, and overall, a poor user experience. Decentralized exchanges were mostly used by cryptocurrency veterans who were unimpressed by the DIY nature of trading on niche platforms. But then things changed. A very big change.

Trading on DEX today can be as easy as trading on a centralized exchange. A lot of work has been done on the user interface to make it more intuitive for cryptocurrency traders of all experience levels. With the rise of DeFi, liquidity on top DEXs such as Uniswap, MDEX, PancakeSwap, SushiSwap and 1inch Exchange has improved dramatically. And with exceptional next-generation blockchains like Solana offering more robust functionality for many projects based on their blockchains, trading assets on-chain no longer comes at the cost of lower speeds.

It still requires individual traders to take on the responsibility of managing their own keys and wallets. On DEX, it’s all up to you.

Posted by:CoinYuppie,Reprinted with attribution to:https://coinyuppie.com/the-evolutionary-path-of-exchanges-traditional-centralized-and-then-decentralized-exchanges/
Coinyuppie is an open information publishing platform, all information provided is not related to the views and positions of coinyuppie, and does not constitute any investment and financial advice. Users are expected to carefully screen and prevent risks.

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