Decentralized Exchanges (DEX)
DEX or a decentralized exchange is a platform that offers users to conduct cryptocurrency exchange operations, to carry out staking, farming. There is also such a definition of DEX. These are exchanges operating on the basis of a distributed registry that do not store finances and personal data of clients on servers. Trade transactions are conducted without the participation of intermediary structures.
An important caveat is that many decentralized exchanges cannot be fully called such. The reason is that to store information about trade transactions and applications for the purchase and sale of virtual currencies from customers, their own servers are used, although exchanges do not have access to private keys.
What are the differences between DEX and CEX?
A centralized exchange is managed by a legal entity or individual. In turn, the administration of such an exchange assumes responsibility for ensuring the protection of customer information, provides control over the functioning of the exchange, decides how the exchange will develop further.
Unlike them, DEX is controlled in automatic or semi-automatic mode. There is no single governing body. The exchange’s clients are directly involved in the development of the platform. DEX allows customers to interact directly, using the blockchain to store and process transactions.
The principle of functioning of centralized and decentralized exchanges is completely different.
A centralized exchange is in many ways similar to a banking structure. The client deposits cryptocurrencies, the platform stores them, executing withdrawal requests, asset exchange. In fact, the platform manages the client’s funds.
A decentralized exchange does not store customer funds. The protocol matching orders is activated. Funds are transferred between users’ crypto wallets, and smart contracts are used for this purpose.
Types of DEX
Decentralized exchanges are classified based on two criteria.
Place of transaction
The exchange is carried out on the main blockchain, or third-party, and then transfer the results of the exchange to the main blockchain. A third-party blockchain is used if the main blockchain is overloaded and the asset exchange process needs to be accelerated.
Transaction execution method
Some of the exchanges use orderbooks, but an automatic market maker is increasingly being used. Its meaning is that users create pools of liquidity. They exchange currencies based on the existing market rate, as well as supply and demand.
How DEX works
Almost all decentralized exchanges use automated market makers (a protocol that ensures the liquidity of assets). Assets are automatically traded based on the specified mathematical formulas. Liquidity pools are created, they are traded using trading terminals.
The funds for financing such pools are provided by clients. In return, they are paid% of the fees. The exchange’s algorithms set the value for virtual coins based on the dynamics of supply and demand.
The user connects his wallet that supports the exchange’s blockchain, most often it is Metamask. He places an order to exchange his asset for another one that is on the exchange. If an order is placed to sell an asset, then other participants can place purchase orders. Purchase orders are viewed and executed by both parties.
If a client wants to trade on DEX, he uses an interface that almost does not differ from the one in a centralized platform. He selects a trading pair, studies the history of transactions, indicators, places a sell or buy order, can cancel or change an already established one.
The transaction is confirmed in a wallet that is connected to the DEX website. After confirming the transaction in the blockchain, the order appears on the site of the platform in the list of orders. The trader can change its parameters or cancel it altogether, if he sees fit. For such actions, you need to pay the exchange commission.
The main advantages of DEX
Since the decentralized exchange has a distributed architecture, and there is no single control center, it guarantees privacy for users. For many traders and investors, this is the main argument for using a decentralized exchange.
DEX does not store clients’ finances. Accordingly, the hacking of cybercriminals, the termination of the exchange will not lead to the fact that the user will lose funds. This is another important advantage over centralized sites, they are periodically hacked and funds worth millions of dollars are stolen.
There is no personal account, verification is not required, the user does not provide email. Therefore, the client’s personal information cannot be stolen and used for malicious purposes.
Manipulation of asset prices on a decentralized exchange is excluded, since there is no single management body that would be interested in this.
State authorities, regulatory structures cannot issue permission to freeze customer accounts, impose sanctions against them, as some centralized platforms are forced to do now.
Nevertheless, some disadvantages of DEX should be pointed out.
Disadvantages of DEX
Almost all DEX do not offer margin trading, landing, stop losses for clients. That is, trading opportunities are limited when compared with a set of tools from centralized platforms. Liquidity pools are smaller, there is no support service, so users cannot get comprehensive answers to their questions. There are no other disadvantages of DEX.
Will decentralized platforms be regulated?
In some countries, such as Singapore, there are some by-laws with which they try to regulate the activities of DEX to some extent. So far, no regulatory framework has been created for such platforms, since there is no legal entity or individual responsible for the operation of the platform. At the same time, it is impossible to exclude the possibility that regulatory authorities will still attempt to put DEX under bureaucratic control.
The most famous DEX
Biswap platform. On this platform, you can exchange cryptocurrencies, there is such a tool as farming. Users can use the referral program, lottery. The commission on the site is small, which allowed it to attract a lot of users. The number of trading pairs for transactions is over 160. The fee is 0.1% and lower.
dYdx. On this platform, it is possible to conduct transactions for the exchange of cryptocurrencies, as well as to issue loans and issue loans to other users. An orderbook (standard order book) is used. It is possible to create margin positions. Registration is not required, the commission percentage is from 0.0025 and up to 0.2%.
Uniswap. This protocol uses liquidity pools to exchange tokens created on the basis of Ethereum. Clients can not only exchange, but also create their own pools of liquidity. In turn, liquidity providers are offered the opportunity to deposit and withdraw funds at any time. Fees are less than 0.3%.
There are different opinions regarding the further development of DEX. A number of experts believe that decentralized exchanges will not be able to attract a significant number of new users, since they provide fewer tools for trading transactions.
At the same time, given the large number of hacks of centralized exchanges, increased pressure from regulators and the imposition of sanctions, it is likely that DEX will become increasingly popular among traders and investors. Despite the fact that the number of trading pairs as a percentage of profit in DEX is not as high as in centralized ones, high security, anonymity, decentralization attract more and more customers.
Therefore, DEX now has significant potential for further development and formation of an alternative global financial market.