Custodial versus Non-Custodial: Exchanges

With extensive experience as an electrical/software/coding engineer along with having a diverse financial background, Thomas Wettermann’s areas of interest include Machine Learning (ML), artificial intelligence (AI), and Financial Technology (FinTech). For the past few years, Thomas Wettermann has focused on the underlying technologies that support and promote all phases of cryptocurrency, Web 3.0, and metaverse ecosystems.

Centralized versus Decentralized Exchange (source:blockgeeks.com)

Introduction

Cryptocurrencies (crypto) are a relatively new type of currency evolving rapidly in an increasingly tech-driven economy. They do not have an actual physical form, but rather exist in a blockchain on a server. They are not backed by banks or other traditional lending institutions, and transactions are highly encrypted to keep personal information private.

Crypto can be purchased, sold, or swapped on different types of cryptocurrency exchanges or on peer-to-peer marketplaces, like LocalCryptos. Once crypto is purchased, it is important to understand how this digital asset should be properly stored and how it can be securely transported or moved.

What is a Cryptocurrency Exchange?

A cryptocurrency exchange provides a platform for purchasing, trading, or swapping cryptocurrencies. There are generally two types of crypto exchanges: a Centralized Crypto Exchange (CEX) and a Decentralized Crypto Exchange (DEX). There is also a hybrid exchange which will be referred to as a Peer-to-Peer crypto marketplace, such as the non-custodial platform offered by LocalCryptos.

What is a Decentralized Cryptocurrency Exchange?

Unlike a “centralized” exchange, a “decentralized” exchange (DEX) avoids the third party or middle man altogether. A DEX establishes a buyer-to-seller or a peer-to-peer trading platform that enables the exchange of one type of token for another different type of token. Say, for example, a buyer wanted to purchase Bitcoin but only had Ethereum to trade or swap. This buyer would use a decentralized exchange or DEX.

DEX’s have several advantages over CEXs. For example, first and foremost, DEXs operate as a non-custodial crypto exchange. This means that investors are not required to turn over control of their private keys to initiate a transaction. Rather, a DEX is typically structured to interface with externally held wallets. Since there is no middle man to process the trade, DEXs often self-execute trades by way smart contracts on the blockchain.

DEXs also typically offer a broader portfolio of supported cryptocurrencies for investors to select. For example, CEXs typically will only offer trading services for the cryptocurrencies that they list, and will generally only list those currencies with adequate trading activity. Therefore, any altcoins are generally not tradable on a CEX, but rather only DEXs.

Alternatively, through smart contracts, DEXs execute trades and record them to the blockchain, enabling trustless transactions. And since DEXs operate as non-custodial exchanges and do not hold the trader’s funds, DEXs are less likely to be targeted by cybercriminals.

Importantly, traders who utilize a DEX also do not need to turn over their private keys because the trader’s wallets are held externally. As such, the DEX is not liable for the funds. For the same reason, users are typically not required to complete know-your-customer (KYC) and anti-money laundering (AML) procedures when using a DEX.

All the views expressed on this site are those of Thomas Wettermann and do not represent the opinions of any entity with which Thomas Wettermann has been, is currently, or will be affiliated.

Trading digital financial assets such as cryptocurrencies can carry a high level of risk, and may not be suitable for all investors. Before deciding to invest, purchase, and/or trade cryptocurrency you should carefully consider your investment objectives, level of experience, adversity to risk, and volatilities. The possibility exists that you may sustain a loss of some or all of your initial investment; therefore, you should not invest money that you cannot afford to lose. You should be aware of all the risks associated with cryptocurrency trading, and seek advice from a qualified and independent financial advisor.

Thomas Wettermann is not an independent financial advisor. Any opinions, news, research, analyses, prices, or other information contained on this website is provided as a general market commentary of Thomas Wettermann and does not constitute investment advice. Thomas Wettermann will not accept liability for any loss or damage, including without limitation to, any loss of profit, which may arise directly or indirectly from the use of or reliance on such information. All opinions expressed on this site are owned by Thomas Wettermann and should never be considered as advice in any form.