The Evolution from Centralized to Decentralized Exchange

In the last article, we explored the primary risk that users face while using a centralized exchange, namely the relinquishing of control of cryptocurrencies’ private keys and personal information to the exchange. As security and privacy are increasingly valued by users, more and more centralized exchanges are implementing decentralized technologies.

The most popular format for a decentralized exchange is a decentralized gateway. This can be thought of as a network of gateway keepers that hold digital assets sent to them by users who are then issued IOUs for trading.

Here is the key improvement over centralized exchanges: the IOUs issued are not stored in a centralized database. Rather, the user retains control over the private keys to their IOUs, which are managed through a blockchain. Furthermore, the actual assets that the gateway hold is controlled by several people or parties via a multi-signature address. This provides an improved measure of security and decentralization.

The users trade IOUs with each other in much the same way as on a centralized exchange, hence retaining many of the efficiency benefits.

However, one could argue that a decentralized gateway is not completely decentralized since digital assets are still controlled by multiple parties. Furthermore, once the user sends their digital assets to the gateway, they only have control over their IOUs and not their true assets.

What if users can trade cryptocurrencies amongst themselves in a truly peer-to-peer manner, without ever handing over control of their private keys? This is the idea behind the atomic swap, a significantly superior basis for a decentralized exchange compared with the decentralized gateway.

Simply put, an atomic swap allows two users to exchange cryptocurrencies across two blockchains with one another, while each retains ownership of their respective assets until a fair outcome for each side is arrived at.

The innovative aspect of an atomic swap is that it simultaneously provides the benefits offered by both centralized and decentralized exchanges: speed, liquidity, and scale.

In the next article, we will explore in more detail how an atomic swap works.

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