Risks of Non-Custodial Exchange Trading
As the cryptocurrencies continue to hit mass media, the risks of cyber theft and scams are also booming for crypto traders. Since there is no regulation governing the trading of cryptocurrencies, such transitions are prone to scams.
Moreover, the exchanges through which cryptocurrencies are traded also have their own pros and cons. Usually, you can trade crypto through custodial or non-custodial exchanges. In this article, we will walk you through the challenges and risks involved in non-custodial exchange trading, even if it is promoted as a safer option through the media.
Understanding the Non-Custodial Exchanges
Non-custodial exchanges, often called “Decentralized Wallets,” or DeFi (“Decentralized Finance”) are the platforms or apps through which you can trade, invest and have complete control over your funds. You will have your private keys to access your funds and perform transactions.
It is imperative to note that exchanges do not explicitly operate non-custodial exchanges, nor take responsibility over your funds. However, under the custodial exchange, your funds are secured by the dedicated exchange houses that control your funds.
Non-custodial exchanges allow you to trade in the cryptocurrency without taking its custody. Since you get complete access to your funds and no central party can control your actions, you might get tempted to trade through non-custodial exchanges only. However, that’s rarely the best choice for your capital.
Non-custodial exchanges have their own unique risks and challenges that could make your experience of trading much worse than you thought. So let us deep-dive into these risks and challenges.
Examples of Non-Custodial Exchanges
Peer-to-Peer (P2P) exchanges are the platforms where buyers and sellers can post their ads about crypto trades. The exchange also protects both parties by adding feedback and rating systems.
The P2P exchanges allow traders to select who can buy their crypto, from whom they can buy, what price to set and when to do the transaction without any third party interference.
Some of the most famous non-custodial P2P exchanges include LocalCryptos, and P2P Validator, that allow crypto traders to trade independently through the platform’s interface.
Decentralized Exchanges (DEX) are another example of non-custodial exchanges. An interesting fact about the DEX is that they do not need any user detail to trade. Instead, all you have to do is to use your public address and trade through the DEX interface, where you get to own your private key, and no one else can bother you for your transactions.
The DEX provides all services that a CEX (“Centralized Exchange”) can offer; however, the transactions are done through an app on a blockchain. DEX also includes trade and order books, trading places, and much more.
Uniswap (V3), MDEX2, Sushiswap, Pancakeswap are some of the top DEX Exchanges offering non-custodial exchange services.
Challenges Faced by the Non-Custodial Exchange Traders
Although non-custodial exchanges provide full ownership of the crypto wallet to the users, traders that such exchanges face certain risks that are rarely overweighing the benefits of these solutions.
Money Laundering Involvement
While using a non-custodial exchange, or another DeFi, you have high risks of getting someone’s “dirty” money and be legally responsible for participating in money laundering. It will be nearly impossible to prove that you are not involved in the laundering scheme (in the recent blog post here we showed a complete case how intelligence units crack such cases).
Market Manipulation
DEX users with substantial funds or knowledge of how to game the system can take advantage of market prices in their own favour eliminating other market participants and making others lose funds to the market manipulator. While on CEXes such cases are monitored by the exchange’s market surveillance systems and they act in the users’ best interest to prevent market manipulation.
Poor Liquidity
In a P2P market, either via standard OTC interface (like LocalCryptos) or via order-book driven exchange (like Uniswap), such implementation always is worse in terms of liquidity than any equivalent custodial exchange. CEX serves precisely the purpose of aggregating liquidity and injecting its available liquidity into the market whenever users need it. Therefore, one of the hidden costs arises here — slippage and high spreads that ultimately affect your returns negatively.
Lack of Dedicated Customer Service
As a user, you get complete ownership of your funds, and the wallet management is up to you; you may sometimes need a help of a customer service team. However, with the non-custodial exchanges, you lose the benefit of using dedicated customer service if you get stuck, and “your own your funds” becomes —” you own your problems”.
Loss of Private Key
The private key is a password key to gain access to your crypto wallet, and hence, it is like your internet banking password. It is provided in the wallet in your app, and therefore, you need to keep it secure and safe so that no one else can ever access your private keys.
The primary challenge of owning a private key is that you may forget what your private key was, and once you forget or lose it, you lose access to your funds in the wallet, forever. Yes, certainly there are tech savvy users who know how to take care of private keys, but typically that’s not the case with the majority of users, and it brings significant challenges to the general market.
Cybertheft
The lack of exchange’s management involvement makes it more prone to hackers, and hence, they can hack your wallet or your device and withdraw your funds without third-party intervention. There are even cases where hackers misrepresent your wallet and fake the balance showing you transactions and earnings, while in reality, you would have no cent and all of you actual funds would already be in possession of thiefs.
Less Regulated
Custodial exchanges typically are regulated (or aim to be) and have a centralized system of managing traders’ funds. Whereas a non-custodial exchange is not regulated by any means, nor does it control the funds of the users. Hence, the risk of cyber theft and frauds increases for non-custodial users, and at a certain point in time, there might be no government agency saving your capital, when you need it the most.
The Bottom Line
Due to the media hype, many users start to switch to the non-custodial exchanges with the freedom they get. However, more freedom always assumes more responsibilities, and with the case of DeFi and DEXs, exchange owners are clearly not the ones who take it.
Loss of private keys, cybertheft, lack of security, poor liquidity, higher costs are the most common problems faced by non-custodial exchange traders. And with the aim to eliminate these barriers, we at as.exchange operate a centralized exchange that is always there to ensure best service for each user at any point in time.
