Currently, centralized exchanges (CEX) are dominating the crypto market. However, lately, decentralized exchanges (DEX) are gaining popularity.
DEXs make peer-to-peer trading easier by using automated smart contracts to perform transactions without the need for a broker. Not all DEXs, however, use the same underlying technology. Some use emergent liquidity protocols, while others stick to traditional order book models.
Developers are creating new aggregation tools in addition to exchange and liquidity protocols to solve the disjointed liquidity inherent in decentralized exchanges.
What Are Decentralized Exchanges (DEXs)?
DEXs, or decentralized exchanges, are Peer-to-Peer (P2P) marketplaces where cryptocurrency traders can trade without leaving their assets to an intermediary. These transactions are made possible via smart contracts, which are self-executing agreements written in code.
The DEXs creation eliminates the need for any authority to monitor and authorize trades within a given exchange. Peer-to-Peer (P2P) cryptocurrency trading is possible on decentralized exchanges and refers to a crypto marketplace that connects buyers and sellers. They are often non-custodial, meaning that users retain control over their wallet’s private keys. Moreover, users can access their coins through a private key, which is a type of advanced encryption. They will not be required to provide any personal information such as names or addresses, which is ideal for all who value their privacy.
Automated market makers and other innovations that solved liquidity-related problems helped attract users to the decentralized finance (DeFi) sector and contributed significantly to its growth. By optimizing token prices, swap fees, and slippage while providing a better rate for users, DEX aggregators and wallet extensions drove the expansion of decentralized exchanges.
How Decentralized Exchanges Work
In terms of feature sets, scalability, and decentralization, there are various DEX designs, each with its own set of benefits and trade-offs.
Order books and Automated Market Makers (AMMs) are the two most common types. On the other hand, DEX aggregators examine several on-chain DEXs for the best price or lowest gas fees per requested transaction. The high degree of determinism provided by employing blockchain technology and immutable smart contracts is one of the key advantages of DEXs. Centralized exchanges like Coinbase or Binance support trading using the exchange’s internal matching engine. Unlike them, decentralized exchanges execute trades using smart contracts and on-chain transactions.
Types Of DEXs
There are three types of decentralized exchanges:
- Automated Market Makers (AMMs)
- Order Book DEXs
- DEX Aggregators
Automated Market Makers (AMMs)
To solve the liquidity issue, developers created a smart contract-based automated market maker (AMM) system. These exchanges were partly inspired by Ethereum co-founder Vitalik Buterin’s paper on decentralized exchanges. The paper explains how to execute trades on the blockchain via token-holding contracts.
Blockchain oracles set the price of traded assets, which are blockchain-based services that provide information from exchanges and other platforms. These decentralized exchanges’ smart contracts employ pre-funded pools of assets called liquidity pools instead of matching buy and sell orders.
Order Book DEXs
Order books track all open buy and sell orders for specific asset pairs. Buy orders show a trader’s willingness to buy or bid for an asset at a certain price. Sell orders indicate a trader’s willingness to sell or ask for the asset in question at a given price. The two types of DEXs are on-chain order books and off-chain order books.
Open order information is often held on-chain by DEXs that employ order books, while users’ assets stay in their wallets. Traders on these exchanges may be allowed to leverage their positions by borrowing money from lenders on the platform.
DEX Aggregators use a variety of protocols and strategies to address liquidity issues. These platforms aggregate liquidity from many DEXs to minimize slippage on large orders and optimize swap fees and token prices. As such, they are providing traders with the best price possible in the smallest period of time.
DEX Aggregators also aim to protect users from the pricing effect and reduce the possibility of unsuccessful transactions. Some DEX Aggregators also employ liquidity from centralized platforms to provide users with a better experience while maintaining non-custodial through interaction with particular centralized exchanges.
List Of Decentralized Exchanges
Currently, Uniswap holds first place as the most popular decentralized exchange (DEX) in terms of trade volume. It was the first Ethereum network DEX, allowing you to exchange any ERC-20 token on the Ethereum blockchain. There are now several versions of Uniswap. Because of the protocol’s decentralized structure, it is impossible to simply remove previous versions after an upgrade. Hence, there are currently three versions, with V3 being the latest.
PancakeSwap is a native BNB Chain decentralized exchange. In other words, it is similar to UniSwap in that users can trade their coins for other coins without the need of an intermediary. The only difference is that PancakeSwap focuses on BEP-20 tokens, a Binance-developed token. The BEP-20 standard is simply a checklist of features that new tokens must have in order to be compatible with the Binance ecosystem of DApps, wallets, and other services.
QuickSwap is a version of the market-leading UniSwap decentralized exchange launched on the Polygon blockchain in September 2020. Polygon is a faster and less expensive smart contract platform than Ethereum, making it a popular choice for high-throughput and gas-intensive DeFi protocols. QuickSwap is also the second-largest application on the Polygon network. It has approximately 20,000 active users, 5,000 liquidity providers, 609 trading options, and a 24-hour trading volume of $125 million.
SushiSwap was split from Ethereum in September 2020, just before QuickSwap. It has about $2.34 billion in liquidity spread across 2,585 trading pairs. SushiSwap uses multichain software to enable trades on 14 different blockchains, including BSC, Polygon, Arbitrum, xDAI, and Fantom. Its DeFi ecosystem includes yield farms, borrowing and collateralization products, and a lending protocol in addition to its decentralized exchange.
Advantages and Disadvantages of DEXs
Trading on decentralized exchanges can be pricey, especially if network transaction fees are high when the trades are executed. However, there are several advantages of using DEX platforms.
Before listing tokens on centralized exchanges, they must be individually vetted to ensure they meet local regulatory requirements. Decentralized exchanges can include any token generated on the blockchain upon which they are built, implying that new projects will likely list on these exchanges before their centralized counterparts.
On DEXs, the user’s identity is protected when trading one cryptocurrency for another. Contrary to centralized exchanges, users are not required to go through a standard identification process known as Know Your Customer (KYC). KYC procedures involve collecting personal information from traders. As a result, DEXs attract a considerable number of people who prefer to remain anonymous.
Because DEXs do not control their assets, experienced cryptocurrency users who have custody of their funds are less at risk of being hacked. On the other hand, traders keep their funds safe and only interact with the exchange when they want to.
Liquidity is achieved by centralized exchanges and an enormous amount of capital. DEXs often face this issue because, unlike centralized exchanges, their liquidity depends on how many users actively trade on the platform. Furthermore, they often lack access to a fund that would make trading more straightforward.
Smart Contract Vulnerability
Smart contracts on blockchains like Ethereum are open source, and anyone can review their code. These contracts, on large, decentralized exchanges, are also examined by popular companies, which helps to ensure the code’s security. Moreover, programming errors creep in easier. Thus, exploitable vulnerabilities can slip audits and other code reviews.
- Decentralized exchanges (DEXs) make trading easier without needing an intermediary.
- There are three types of DEXs: Automated Market Maker, Order Book DEXs, and DEX Aggregators.
- Automated Market Makers (AMMs) and DEX Aggregators help solve liquidity problems.
- Order Book DEXs track all open buy and sell orders.
- UniSwap is the most popular decentralized exchange.