Exchanges play a key role in the cryptocurrency economy. They provide market liquidity, and customers the ability to purchase digital assets with relative ease and low costs. Ideally, they also provide peace of mind, additional tools to assist in buying and selling, and more benefits for traders.
You may be familiar with ‘centralized exchanges’ already as they make up both a majority of exchanges, as well as a large part of the total trade volume across all exchanges.
Decentralized exchanges, however, are a newer phenomenon which peaked in user and public interest back in early 2018. Since then however, they have been struggling to beat centralized exchanges in terms of total trade volume
Hybrid exchanges and solutions are starting to make headway in 2019, attempting to enter the spotlight with their “best of both worlds” approach - but the greatest challenge relates to getting people to understand what they offer, as well as what sets them apart from their predecessors and competitors.
I have written this guide to help distinguish between the three in an objective way, however note that I possess a small bias which will be explained at the end of the article.
Centralized Exchanges (CEX)
The majority of exchanges on the market right now are (and historically have been), at their core, centralized. As such are generally referred to as the ‘traditional’ form of a crypto currency exchange.
A January 2019 report from TokenInsight, based on data collected from over 400 exchanges concluded that not only do centralized exchanges make up the majority of exchanges, but they comprise over 99% of all trade volume.
Centralized exchanges are defined by the fact that all trades are processed through an account / wallet that is operated by the exchange as an intermediary. Rather than peer-to-peer (between wallets for which the respective traders are accountable), the centralized exchange acts as a custodian of the user’s digital assets.
Because these intermediary-operated wallets are always connected to an online network - they are referred to as ‘hot wallets’ and as such, act as ‘honey pots’. This attracts thefts from hackers or fraud from internal agents.
Furthermore; the lack of transparency regarding funds, volume etc has lead to a wide-spread issue where exchanges have been found to be submitting fake reports and numbers to data aggregators such as CoinMarketCap.
Pros:
Pros:
- Platform takes on associated legislative and custody risks (KYC and AML).
- Additional customer support + other intermediary services.
- High liquidity due number of traders, trader activity, and fiat conversion availability.
- Known for being much more responsive and easy to use.
Cons:
- Against the original ‘ethos’ and ‘tenets’ of crypto à la Bitcoin whitepaper / Satoshi.
- Lack of transparency regarding funds storage.
- Security issues: frequent targets of successful attacks, potentially higher possibility of money laundering activity.
Decentralized Exchanges (DEX)
The number of emerging centralized exchanges in 2018, according to the TokenInsight report, was equivalent to that of the previous year. Conversely, the number of new decentralized exchanges in 2018 was significantly higher compared to 2017.
Decentralized exchanges do not use centralized intermediary for transactions, and instead allow buyers and sellers to locate and transact with each other directly on-chain. Trades happen wallet-to-wallet or peer-to-peer.
They rose to prominence in January 2018, the month during which they reached their highest trading volumes. Since then, whilst the number of exchanges has grown - the trading volumes and active user counts are minimal.
Additionally, only a handful of decentralized exchanges at present dominate the market and are based on either the EOS or Ethereum blockchain infrastructure. Along with this, liquidity is significantly lower than that of centralized exchanges due to this lack of active users. However, it’s important to note that centralized exchanges are known for multiplying their volumes, possibly even over ten-fold of what actual volume may be.
Pros:
Pros:
- No exchange-based centralized wallet: keeps funds safe from risk of hacking or theft.
- Reduced trader dependency on a centralized platform.
- Deal-matching and asset liquidation are realized through smart contracts, and user funds are under their own control.
Cons:
- Expensive and slow.
- Unpopular = Low liquidity.
- Full user-accountability may not be suitable for all types for user.
- Might not survive mounting regulatory pressure as decentralized exchanges aim to be anonymous in use.
- Vulnerable to ‘front-running’.
Hybrid Exchanges (HEX)
Most recently, we have seen the emergence of a new approach to cryptocurrency exchanges - seeking to forge a middle ground between the dichotomy of ‘centralized’ and ‘decentralized’ exchanges with a new “best of both worlds” approach.
Hybrid exchanges seek to combine the liquidity, functionality and customer support functions of traditional centralized platforms - with the security and sovereignty / privacy of decentralised exchanges.
To achieve this: an order book is operated on-chain in which all transactions are immutably recorded and presented on a relevant Blockchain transaction explorer - whilst the function of the exchange is to calculate the priority of transactions (based on value and fee adjustment).
Tokens are never left sitting on an exchange ‘hot wallet’, which is typically overseen by management, but are instead moved directly from account-to-account; peer-to-peer - increasing security from theft and removing human risk that can result in wash trading and misappropriation of client funds.
Compared to a decentralised exchange, a hybrid exchange can offer improved usability and adequate transaction clearances when popularly used Blockchains for DEX platforms, mostly Ethereum, experience bottlenecks.
Conclusion: What Do I Think?
My name is Gleb Jout and I am the recently appointed Chief Executive Officer at NEXT.exchange, a hybrid exchange based in the Netherlands and Alpha launched in 2018 (with additional registration in England and Wales) that will be operating on its own Blockchain, NEXT.chain.
NEXT.exchange is a hybrid cryptocurrency exchange (HEX) which provides all traders with their own individual wallets and ultimately access to private keys for each respective cryptocurrency - with the aim of giving every trader sole control over their wallets. The exchange is currently in community beta, for a recent update, click here.
Our goals include:
- Providing users full account autonomy, and control over their wallets.
- Fill a gap in the current digital assets market: needed “to facilitate its growing adoption”.
- Support mass crypto and blockchain adoption.
- Fulfil compliance: legal, transparency, and public trust obligations.
- To ensure that all products and services offered are fully compliant with regulatory and legal requirements.
NEXT.chain (with PoW, PoS and ITC layer) acts as the foundation upon which the NEXT.exchange hybrid trading platform will operate.
We built our own chain because we don’t believe that most “active” blockchains on the market right now are capable of handling the number of transactions required by what we consider to be a mass and growing market. It also means that we can identify and address any potential areas for improvement in security, without having to wait for action from a ‘parent chain’.
Here is a quick summary of some of the other benefits from NEXT.exchange which you won’t find together elsewhere.
- Strong security provisions, and support.
- Low trading fees depending on account tier (when holding ‘NEXT’).
- Users can deposit, trade, and withdraw fiat currency.
- Fiat pairings for all on-exchange assets, post KYC.
- Auto staking of proof-of-stake based assets
- Additional utility unlocked by holding ‘NEXT’ tokens.
- Last but not least, NEXT will distribute all collected fees (mins operating costs) of the platform back to NEXT users!