What Is a Decentralized Exchange (DEX)?
If you take some interest in cryptocurrencies, you have probably heard of a decentralized exchange and maybe even wondered “What is a DEX?” Before deciding to use it, you should be aware of all its features and principles of operation. We will also tell you about the advantages and disadvantages of DEX and provide you with a list of the best platforms where you can buy or sell cryptocurrency. Well, let's start small and puzzle out what a decentralized exchange is.
What is DEX exchange? It is a crypto exchange that operates on the basis of a distributed ledger, does not store user funds and personal data on its servers, and acts only as a platform for matching requests for the purchase or sale of user assets. Trading on such platforms is performed directly between participants (Peer-to-Peer) without any financial intermediaries.
How do Decentralized Exchanges Work?
DEX is a trading platform where an investor can buy, sell, or exchange one digital asset for another or for a traditional fiat currency. The key task of a DEX is to support transactions with digital assets. However, the features of crypto exchanges are not limited to this. In these recent times, the most popular trading platforms have done a great job of diversifying their lines of activities. For example, they began to provide clients with margin trading and custodial services for storing funds.
Most decentralized exchanges use automated market makers. AMMs are protocols that provide liquidity to all assets in the market. Instead of the order book found on traditional exchanges, assets are automatically traded according to pre-set mathematical formulas.
In the context of CEX, a market maker is an organization that monitors and maintains the liquidity of instruments so that buyers always find sellers and vice versa. Decentralized exchanges perform the same task, but without the need to store the assets themselves. Instead, a platform creates liquidity pools from tokens that are traded through its terminals. The capital for funding these pools is provided by users in exchange for a percentage of fees. Under this scheme, the entire burden of market making is shifted to liquidity providers.
The DEX algorithm sets the price for assets in accordance with the dynamics of supply and demand, and the fee for pooling tokens is also adjusted depending on these dynamics.
Advantages and Disadvantages of a Decentralized Exchange (DEX)
After we gave the answer to the question “What is DEX crypto?” and puzzled out how it works, we can analyze what pros and cons such crypto services have. Let's start with the benefits.
Advantages of a Decentralized Exchange (DEX)
- You do not need to provide any personal data to use a decentralized crypto exchange. There is no system of registration and verification. Anonymity is one of the main advantages for those who deal with cryptocurrency.
- Your funds are stored in your crypto wallet, and not on the exchange platform. The creators of DEX will not be able to take your funds in any way since they do not have access to them.
- Even the best and most reliable centralized exchanges can fall victim to hackers or experience technical problems. This cannot happen on a DEX platform where each user keeps hold of their private keys.
- Another advantage of decentralized exchanges is their freedom from government control or censorship. The absence of a specific executive team to which sanctions or requirements could be applied prevents the authorities from monitoring transactions made on the platform, stopping trading, and freezing funds.
Disadvantages of a Decentralized Exchange (DEX)
- Probably one of the main disadvantages of DEXs is the difficulty in using them. First of all, it is about the lack of many useful trading tools. For example, there are no stop loss, linked orders, and trailing stop orders.
- DEXs provide pairs of crypto assets within the chosen blockchain. If you have chosen Ethereum, you can exchange only the assets that exist on this network. So it will not be possible to exchange Ethereum for Bitcoin since these are different blockchains.
- The functionality of such services is more complicated than that of their centralized competitors.
- Sometimes, there is poor liquidity on DEX exchanges, especially with less popular pairs. Therefore, it can be quite difficult to find someone who is ready to buy or sell an asset at a reasonable price.
- There can be large commissions when performing any action on the Ethereum network.
How to Use DEX
The trading interface of decentralized exchange websites is now very similar to that offered by centralized exchanges. On most DEX platforms, you can:
- Choose a trading pair
- Check its schedule
- Add technical indicators to the schedule
- Get acquainted with the order book and the history of transactions
- Check the list of your open orders and completed transactions
- Place a new order and change or cancel an existing one
As a rule, to create an order, you need to perform two or three easy steps:
- Select order type (limit or market).
- Specify the price (in case of a limit order) or volume.
- Click on the “BUY” or “SELL” button.
After that, you need to confirm the transaction in your browser wallet connected to the site. This is the only additional requirement that is unique to decentralized exchanges. When the transaction is confirmed, you will see your offer in the list of open orders and can cancel or change it some time or other.
Please note that canceling an order is another transaction on the blockchain. So you will need to pay a fee again. And changing an order implies two transactions (canceling the old one and placing a new one), so you will have to pay a commission twice.
Best Decentralized Crypto Exchanges 2022
Not sure which DEX to choose? We are always ready to help you. Take a look at our list of the best crypto platforms 2022 and choose the one that suits you the most.
- Uniswap
Uniswap is a decentralized protocol for exchanging Ethereum tokens that uses liquidity pools instead of order books. Within the platform, you can exchange tokens, create and manage your markets (liquidity pools), view your share in the liquidity pool, explore current exchange rates, etc.
Liquidity providers can deposit or withdraw their funds at any time. They receive an incentive in the form of UNI tokens for depositing funds. First, the creator of the pool sets the desired rate, which is then automatically adjusted when trading.
- SushiSwap
SushiSwap, like Uniswap, is an AMM-based decentralized exchange protocol that uses liquidity pools. Any user can create a liquidity pool by providing ERC-20 tokens or Ethereum. Prices are generated automatically. SushiSwap is driven by community – holders of the SUSHI token, which is distributed as a reward for supplying liquidity, have the right to vote on the governance of the project. SushiSwap allows you to exchange tokens, manage your finance and liquidity pools, and receive rewards for investing assets and staking.
- Aave
Aave is an open-source non-custodial Ethereum protocol whose main function is decentralized lending. The ERC20-compliant aTokens that the protocol provides for lenders are created in the same quantity as user-supplied coins. After that, the accrual of assets begins.
Users have the right to borrow funds against the supported assets. Each token has its liquidation period, required amount of bail, default penalties, interest rates, etc. Thus, the protocol allows you to exchange your assets for the necessary ones at any time without selling them.
- Balancer
Balancer is another automated market maker powered by Ethereum. Users can create pools or add liquidity to existing ones. At the same time, instead of the traditional distribution model, it is allowed to use any number of assets for one or another side of the trading pair. Subsequently, a user earns income based on the transaction fees of other participants. There are different types of pools (private, public, smart pools), which differ in the principle of control and permissions to change settings.
- Binance
The platform operates on the principle of an order book. All assets are located on the Binance Chain. Matching is done within the nodes of the blockchain, and all transactions are permanently recorded, thus forming a complete and transparent history of activity.
Also, there is a testnet – a special network where you can try your hand at trading without investing real assets. This is a great way to apprehend the essence of the platform.
FAQ
How does a DEX make money?
DEXs are created not only to provide trading services but also to make money. Like any exchange, DEXs earn a profit on the fees that users pay for placing, changing, and deleting their orders, making exchanges, and other services.
What are DEX trades?
DEXs are designed to provide services for buying, selling, or exchanging one digital asset for another or for traditional fiat currency. Trading takes place directly between participants without intermediaries and centralized authorities.
What is the best decentralized exchange?
We’ve presented a list of the best decentralized exchanges for 2022. All of them are reliable and safe. Uniswap is the most popular platform with a large number of cryptocurrencies and trading pairs. Binance is best suited for beginners as it offers a testnet to get familiar with the exchange.
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