A decentralized exchange (DEX for short) offers customers the opportunity to trade cryptocurrencies. In contrast to conventional crypto exchanges, these are not centrally managed but are based on blockchain technology. For example, the management of the order book and the merging of buy and sell orders are carried out decentrally.
Do you want to know more about decentralized exchanges? Then take a look at the relevant BTC-ECHO ACADEMY entry.
What is a DEX?
A Decentralized Exchange (DEX) is a cryptocurrency trading venue where players trade directly with each other. In contrast to centralized exchanges (CEX), users on decentralized exchanges can trade anonymously and are not dependent on an intermediary third party.
So, a decentralized exchange (or DEX) is a peer-to-peer marketplace where transactions take place directly between crypto traders. DEXes fulfill one of the most important possibilities that cryptocurrencies or blockchain technology enable: the promotion of financial transactions that are not carried out by banks, brokers or other intermediaries. Often leveraging the Ethereum blockchain, DEXes are part of the growing range of decentralized finance tools that make a wide range of financial services available directly through a compatible crypto wallet.
Do you want to know more about decentralized exchanges? Then take a look at the relevant BTC-ECHO ACADEMY entry.
How does a DEX work?
Unlike centralized exchanges like Coinbase, DEXes do not allow exchanges between fiat and crypto. Instead, they exclusively trade cryptocurrency tokens for other cryptocurrency tokens. Through a centralized exchange (CEX), you can trade fiat for cryptocurrencies (and vice versa) or crypto-crypto pairs. However, trading on a CEX requires a detour via a bank. You can often also carry out more advanced transactions, such as margin trades or limit orders. However, all of these transactions are processed by the exchange itself via an “order book”. This sets the price for a specific cryptocurrency based on current buy and sell orders. So the same method that exchanges like Nasdaq use.
Decentralized exchanges, on the other hand, are a series of intelligent contracts (smart contracts). They algorithmically set the prices of different cryptocurrencies against each other and use “liquidity pools”. Investors deposit crypto assets there in exchange for interest-like rewards. This enables trading and ensures liquidity.
While transactions on a centralized exchange are recorded in that exchange’s internal database, DEX transactions are settled directly on the blockchain.
DEXes are usually based on open source code. This means that, in theory, anyone interested can see exactly how they work. This also means developers can adapt existing code to create new competing projects. Accordingly, Uniswap’s code has been adapted by a number of DEXes with “Swap” in their name, such as SushiSwap and PancakeSwap.
Do you want to know more about decentralized exchanges? Then take a look at the relevant BTC-ECHO ACADEMY entry.
What are the advantages and disadvantages of a DEX?
Advantages
Anonymity: No personal information is required to use most popular DEXs. Users can trade without having to go through a KYC (Know Your Customer) process.
Big variety: If you’re interested in finding a token that’s still in its infancy, look no further than DeFi. DEXes offer a virtually unlimited selection of tokens, from the well-known to the completely unknown.
Usefulness in developing countries: The peer-to-peer lending, fast transactions, and anonymity that DEXes enable make decentralized exchanges particularly popular in developing countries. Especially when there is no solid banking infrastructure. Because anyone with a smartphone and an internet connection can trade via a DEX.
No central party: Customers can trade with each other peer-to-peer. Banks, brokers or other intermediaries become unnecessary. This means that fees are usually lower than on centralized exchanges. The coins are in your wallet and not on the exchange.
Disadvantages
Customer service: In contrast to CEXes, DEXes usually have no support or contact person. So if you make a mistake or experience problems, there are limited options for help (e.g. a community forum).
Hot Wallet Storage: Since the tokens are on your own wallet, you are responsible for safekeeping your coins.
Low liquidity: Despite their rapidly increasing number of users, DEXes are not yet that widespread. Therefore, there may be temporary restrictions on liquidity. Especially on smaller exchanges. However, problems of this kind are rare and are considered to be almost solved due to increasing usage.
No FIAT crypto exchange: Only cryptocurrencies can be exchanged for other cryptocurrencies on DEXs. An exchange for fiat money is not possible. So you first have to link a wallet with cryptoassets to the respective decentralized exchange.
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