Its native capabilities such as its decentralized nature, high-speed internet access, and the ability of recording transactions in a peer-to-peer network have demonstrated how blockchain technology can be used to transform global trading. Even though the development of new technologies, advanced computer software, and high-speed internet access can greatly improve traditional trading systems, investors still face certain challenges until blockchain brings real technological advancement. Blockchain introduced the idea of decentralization in trading. Traditional exchanges were centralized platforms and are controlled by central authorities.
The approval of transactions and the completion of the exchange process on a central trading platform can take several days. Such a time-consuming approach seems unconvincing when everyone is too busy.
Trading markets have been increasingly incorporating blockchain integration into their existing platforms to address these issues. They are gaining a competitive advantage and bringing high efficiency, transparency, accuracy, and transparency across trading exchanges. Blockchain's central concept is to shift control and decision-making authority from a centralized system into distributed networks. This allows for fraud prevention and avoids the manipulation of records.
What is a Centralized Exchange?
A centralized exchange is an online platform that allows for the purchase or sale of digital assets such Bitcoin (BTC), Litecoin, Ether (ETH), Ether(ETH), and tangible assets such as gold and silver. Centralized exchanges have central control and regulation, which is what makes them different from dex and cex. CEXs, in essence, act as middlemen between buyers and sellers who trade, and where the return is generated via transaction fees or commission. Although they have their own regulations and rules, centralized exchanges share the same goal: to give users access to the dominant assets.
For a centralized exchange to succeed, trading volume is crucial. Trading volume is a key component of a centralized exchange's success. It reduces volatility and eliminates market manipulation risks. Companies have been able to launch powerful exchanges with high-quality features that allow traders to invest, trade, and earn decent returns. But, decentralization is now possible on trading platforms thanks to blockchain. There has been a clear shift in preference for decentralized trading over centralized trading.
How does the Centralized Exchange function?
Centralized exchanges have a central authority that is fully responsible for managing and controlling them. Trades can only be performed by traders who trust this authority. Let's take stock exchanges, as an illustration, to show how an exchange works. Stock exchanges allow shares to be traded at live prices and are well-known by most people. While a stock exchange works the same as a centralized one, it facilitates digital asset exchanges and buys, sells, and trades.
KYC (know your client) verification is required by traders in order to be registered on any exchange. The verification includes ID proof and verification of name, address, biometrics, and ID proof. Once verified by the exchange, log-in details are sent to users to log in to their accounts. They can then go through the rules and begin trading in their preferred currencies or assets.
CEX users can not trade assets with one another directly. Alternatively, the exchange may take control of the custody of funds that users deposit. It then issues IOUs of the same amount to traders. They can only exchange them at the moment of withdrawal. This is where we see that IOUs have the potential to be smart contracts in centralized exchanges. It's an informal document acknowledging the debt that one party owes another.
For technical reasons, centralized trades are executed using the Order Book Method. Order book keeps track of all open orders, allowing traders to purchase and sell assets. The person who wishes to purchase an asset must tell the intermediary the estimated cost. Once that intermediary finds the buyer who meets the request, it swaps assets and completes an exchange between them. Order books are not ideal because of the long wait time and the inability of traders to verify the transaction.
What is a "Decentralized Exchange"?
Blockchain's most well-known use case is the decentralized trading platform. This lets people trade digital assets securely and transparently with each other. A DEX can facilitate the trade of all virtual coins and has the same features as a centralized one. So traders don't have to worry about having limited coin listing in DEXs, as they would with a centralized exchange.
Third parties manage security and funds at centralized exchanges. They are similar to banks or stock exchanges. DEXs can replace the role of third parties through precoded smart agreements that allow users to easily execute trades.
How does decentralized exchange function?
Many iterations have been made to decentralized exchanges. While the first-generation DEXs utilized order books that work like stock markets and centralized exchanges, the most recent decentralized exchanges utilize an entirely new mechanism called the Automated market Maker. Let's take a look at each method in this context.
Order book method
An order book is a database that compiles and maintains open transactions to facilitate the buying and selling of assets to traders. The smart contract needs the asset's estimated value to be sent to anyone who wants to buy it. Once the smart contract matches the buyer's request it swaps assets and gives the buyer what he wants.
To sell his assets, one can submit the asset for a smart contract and then wait until suitable buyers are found. Either way, he will be able to check the order books, find a buyer and then complete the process.
Two types are available for order books:
1. On-chain ordering book: A decentralized, order-based order-based exchange on the blockchain that uses nodes to keep all open orders. This method requires miners who validate each transaction.
2. Off-chain ordering book: Unlike on-chain, off-chain order-based decentralized exchanges require a centralized entity in order to host transaction records. Trading occurs on a decentralized peer-to-peer network. Therefore, the off-chain order-book DEXs can be described as semi-decentralized.
The Order book method is used by many DEXs, but it has its limitations. One of these is the requirement to deposit assets prior to the trade being initiated and the trust requirement for a centralized authority. This allows decentralized exchanges to maintain their momentum.
Automated market maker technique (AMM)
The automated market maker method is a popular algorithm that's used by decentralized platforms like Uniswap, Sushiswap, and others. It is used to solve the liquidity issue of the order book method and provides many other benefits. AMM method doesn't require traders to agree to transaction terms. They also don't need trades that are compatible for long periods of time. Instead, they can trade quickly using a pool that automatically executes trades based only on certain parameters.
The trading pool, which is essentially a liquidity pool, follows the principle that demand and supply. The liquidity pool gradually raises the price of each token purchased by traders. However, each token sold by a trader causes the pool to decrease in value. This is how the exchange system works/goes completely automated. It eliminates security and counterparty risks.
To read more - https://www.leewayhertz.com/exchnage-vs-dex-vs-swap/
Comments
Post a Comment