Question

Trading in electronic exchanges has grown tremendously in recent years. What are some of the disadvantages of trading in decentralized electronic exchanges? Give a very brief description about ‘High Frequency Trading, HFT’.

Answer 1

Solution:

A decentralized electronic exchange is a cryptocurrency trading platform which does not rely on a third-party service for holding the cryptocurrencies of a customer. The problem of hacks arises when cryptocurrencies are stored with the exchange. However, if the exchange doesn’t have the currencies - there is no risk of hacking as the currencies are stored securely with the traders in their wallets. Decentralized exchanges are popularly abbreviated as DEX.

Disadvantages of Decentralized Exchanges:

a)Suspense over Ownership:

Considering that decentralized cryptocurrency exchanges are often used to bypass regulatory sanctions, owners of decentralized exchanges usually like to remain anonymous. However, considering that anonymity has been a big part of the crypto-culture for years, this might not bother many users if the exchange has a proven track record of a few years. Anonymity and cryptocurrencies go hand in hand.

b) Not Beginner Friendly:

A major drawback when it comes to decentralized exchanges is they are not beginner friendly. Especially for a user who is an absolute first-timer to the world of cryptocurrencies, DEX platforms can be a little overwhelming. Unlike centralized platforms, they are not heavily reliant on a user-friendly UI.

c) Public Awareness:

While this is a temporary disadvantage, it deserves a mention here because there is a serious lack of awareness among the users about decentralized exchanges. While centralized exchanges continue to gain tens of thousands of users with every passing day, decentralized exchanges are yet to catch up.

d) Liquidity:

On most dexes you will struggle to get liquidity, which means the order books will be thin and it will be difficult to get a fair price for your trades.

e) Limited Functionality::

Dexes are normally fairly simple, with limit and market orders, and not a whole lot else. Centralized exchanges are better kitted out in most ways.

High Frequency Trading (HFT)

High-frequency trading, also known as HFT, is a method of trading that uses powerful computer programs to transact a large number of orders in fractions of a second. It uses complex algorithms to analyze multiple markets and execute orders based on market conditions. Typically, the traders with the fastest execution speeds are more profitable than traders with slower execution speeds. A High-Frequency Trader uses advanced technological innovations to get information faster than anyone else in the market. With this information, the trader is able to execute the trading order at a rapid rate.

The major benefit of HFT is it has improved market liquidity and removed bid-ask spreads that previously would have been too small.