What is a decentralized exchange?
Decentralized exchanges (DEX exchanges) are platforms for trading crypto assets that allow users to interact directly without any intermediaries like centralized exchanges: Binance, Coinbase, ByBit … All operations with cryptocurrency occur through smart contracts. DEX simplifies the trading process between traders while not controlling their assets.
Decentralized exchanges are built on leading blockchains that support smart contracts. Many popular exchanges, such as Uniswap, operate on the Ethereum blockchain.
What is the difference from centralized exchanges?
Centralized exchanges operate on the principle of regular stock exchanges. The administration of such a platform can be compared to a bank — it is a legal entity responsible for the security of users' assets and must comply with applicable laws.
DEX exchanges do not act as intermediaries in users' operations and are not responsible for their security. Therefore, registration and verification are not required on such platforms. There is also no option for storing funds; you can exchange coins simply by connecting your wallet.
Another important difference is that decentralized exchanges do not work with fiat assets. This means you must already have some cryptocurrency stored in a wallet. You cannot buy tokens using a bank card, as on centralized platforms.
DEX offers users a number of advantages:
Privacy. You do not need to register, undergo a verification procedure, or provide your personal data to the platform administration. All processes are completely anonymous.
The absence of a single management center. This reduces the likelihood of hacking attacks and eliminates risks associated with third-party interference, such as exchange management or government authorities. Thus, your funds or transactions cannot be blocked or subjected to any other restrictions.
No need to trust your funds to the exchange. You are responsible for the storage and security of your assets.
Diversity of projects. There are many new or rare tokens that are available exclusively on decentralized platforms.
Interesting opportunities for participants. For example, passive income from investing tokens in liquidity pools. Users can also participate in system management through farming its governance token.
DEX exchanges also have drawbacks:
Limited functions. There are no features such as margin trading and other functions familiar to experienced traders.
Complexity for the user. Beginners may find it difficult to figure out how to work with the platform. Although the interface is usually simple, you need to know how and for what to use it.
High risk of fraud. Fraudsters can implement criminal schemes by creating fake tokens.
Lack of customer support. If you make a mistake, encounter fraud, or something else goes wrong, no one will be able to provide practical help. The platform may have a section for asking questions and getting answers, but this concerns general information about working with the system.
Beginners should start by working on centralized exchanges, as this is simpler and safer for inexperienced users. More advanced traders usually use both options. Centralized platforms are chosen when fiat transactions or extended functionality is needed. Decentralized exchanges are used for trading tokens that cannot be found elsewhere, as well as in cases where anonymity is required.
Types of decentralized exchanges
There are several types of DEX depending on how smart contracts are used in the blockchain network:
Order books on-chain. This system implies storing all transactions, purchase requests, their changes, or cancellations in the blockchain. This approach provides transparency, as everything happens without third-party involvement. However, all processes are slow and often more expensive due to additional fees.
Order books off-chain. All operations occur off-chain, with only the transaction itself executed on the blockchain. This is a faster and cheaper way to exchange. Its drawback is the vulnerability of the security system.
Automated Market Maker (AMM). This method implies abandoning the order book, providing automatic trading according to a specific algorithm. Thus, you do not need another trader on the other side to conduct a transaction. You interact with a smart contract.
DEX aggregators. They combine various exchanges into one trading platform. Here, you can view information on the tokens of interest from a single interface and choose the most profitable fees. Aggregators do not need to manage liquidity pools of traders, as in the AMM model. This category includes 1inch, 0x.
Currently, most platforms operate on the automated market maker model, where users can create liquidity pools and earn a percentage of the fees. Aggregators are becoming increasingly popular.
Conclusion
A decentralized exchange allows trading cryptocurrencies outside a centralized system directly between users through the use of smart contracts.
The main difference between DEX and centralized exchanges is the lack of centralized management and control over transactions. Users interact directly.
The main advantages of decentralization are anonymity, the impossibility of imposing any restrictions on users' accounts, the ability for users to participate in the management of the exchange, protection against hacking, and a variety of trading pairs.
Among the drawbacks, one can highlight the impossibility of canceling or disputing a transaction, lower liquidity, limited functionality, and the absence of a full-fledged customer support service.
Currently, most decentralized platforms operate on the AMM principle, which provides automatic trading.
