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Understanding Decentralised Exchanges

Decentralised Exchanges

Decentralised exchanges are applications that allow users to buy and sell cryptocurrencies. They are safer than centralized exchanges, allowing for more secure investments which users can feel comfortable with. While many decentralized exchanges have proven to be very difficult to use, a trend has taken place which involves heightened demand for decentralized exchanges.

New Solutions

Decentralized exchanges provide several key solutions to the problems experienced with centralized exchanges. Decentralized exchanges help to protect financial and data security of users, provide lower trading fees, and give users more control over their investment decisions.

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More decentralized exchanges are becoming easier to use. Such exchanges include VDEX, KyberSwap, and Paradex. With VDEX, communications across different blockchains is possible.

Liquidity Problems

Many decentralized exchanges face liquidity challenges. While some exchanges have made progress in improving liquidity, many still face infrastructural deficits which make their use very unattractive. Most decentralized exchanges offer their trading services on one blockchain. Many cryptocurrencies cannot be traded on them due to the fact they are on different blockchains.

Several decentralized exchanges have also made matchmaking of orders much easier for users. 0x Protocol provides a hybrid method for order matching whereby the operation is carry out off-line with an intermediate party, following which the blockchain will execute the actual trade. With the system, anyone can be an off-chain matchmaker by maintaining an order book. Smart contracts on the platform allow matchmakers to set fees for managing transactions.

Kyber exchange uses a combination of smart contracts and reserves to ensure that orders can meet demands. The reserves provide the necessary liquidity while the smart contracts help manage the reserves. The platform maintains a private reserve. Users are able to maintain their own reserves, acting as a source of cryptocurrency for the exchange. Such users may set their reserve. If a user chooses to maintain a public reserve, they can receive contributions from the public who can benefit from sharing in profits.

Regulatory Oversight

Decentralized exchanges are likely to have several effects on the processes by which cryptocurrencies are taxed. As decentralized exchanges do not have central processing of their functions, it becomes significantly more difficult for tax authorities to carry out the supervision required to carry out their functions. For users of decentralized exchanges, this may complicate how they meet their tax obligations, possibly requiring them to spend money on crypto-specific taxation software.

These are some of the factors causing some decentralized exchanges to require KYC information from users. For many users, this may defeat the purpose of having a decentralized exchange which should promote privacy of users. Increasing regulatory pressure has led operators of decentralized exchanges (especially semi-decentralized exchanges) to make.

With time, more exchanges have come on the scene claiming to be decentralized but lacking any evidence to prove such assertions. Users of decentralized exchanges would do well to study the documentation related to exchanges which they use.

Lastly – the fact that cryptocurrencies are still very new means that there is a window of opportunity to start your own crypto exchange.  We’ve thought through the basics of how to do this here.

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