- A decentralized exchange is a platform for buyers and sellers to make transactions without any intermediary party.
- DEXs allow you enhanced security, anonymity and reduced counterparty risk associated with a financial transaction.
In the blockchain landscape, cryptocurrency exchanges play a crucial role in terms of trading virtual currencies. These exchanges, as their name suggests, operate in a decentralized manner, which means without the presence of a third party.
From being accused of manipulating the volume and prices to being exposed to possible hacks, there were many reasons behind this shift from centralized to decentralized. The rising popularity of decentralized exchanges is mainly due to the issues related to centralized exchanges.
What are decentralized crypto exchanges?
Decentralized exchanges, or DEX, are P2P (peer-to-peer) marketplaces where cryptocurrency traders are involved in making transactions between themselves — without the interference of an intermediary. The purpose of DEX was to eliminate the requirement for any custodian or authority to control and administer the trades that are performed within a certain exchange, which is more common in centralized exchanges.
Centralized exchanges need a third party to monitor and execute orders from the order book, they carry additional security risks due to the preservation of private keys, and they are ultimately more time-consuming and costly than DEXs. With the help of decentralized exchanges, traders can facilitate transactions by using smart contracts that are self-executing agreements.
With DEXs, crypto traders are allowed to do peer-to-peer trading of virtual currencies — a marketplace where buyers and sellers are linked to trade cryptocurrencies. DEXs do not provide custody of the crypto assets of the users, which means users keep control of their wallets.
Decentralized exchanges come in three main varieties:
Automated market makers (AMMs)
Trades can be made using the AMM protocol without the assistance of another trader. Instead, you may use a smart contract for trading. Trading is, therefore, peer-to-contract rather than peer-to-peer. Smart contracts are effectively used by the Automated Market Maker system to solve the liquidity issue. AMM helps by setting up a liquidity pool for the investors while lowering the intermediary transaction fees.
Uniswap is one of the most popular AMMs on Ethereum.
Order book DEXs
All open orders for buying and selling particular pairings of assets are recorded in order books. The buy orders signify a trader’s interest in acquiring or offering to buy an asset at a specific price. Sell orders, on the other hand, indicate that the trader is ready to part with the asset at a specified price.
It is comparable to such processes seen in traditional finance, but it is completely decentralized and permissionless, enabling users to work directly with a smart contract to carry out trades from an order book without the need for a middleman.
MDEX has an order book feature that was launched in 2021 to enhance the trading experience in crypto.
They function essentially as trading protocols that source and route liquidity across various DEXs in accordance with predetermined parameters.
1Inch Exchange is one of the best DEX aggregators in the crypto market at present.
How do decentralized crypto exchanges operate?
In order to learn more about a decentralized exchange’s operation, it’s critical to understand how it operates. Contrary to centralized exchanges, DEXs only swap crypto tokens for other crypto tokens, not fiat and cryptocurrency. You can exchange fiat for a cryptocurrency (and vice versa) or crypto-crypto pairs, such as part of your ETH for bitcoin, through a centralized exchange, or CEX.
On the other hand, decentralized exchanges are nothing more than a collection of smart contracts. They employ “liquidity pools”, in which investors lock assets in return for interest-like benefits, to facilitate trades and set the prices of different cryptocurrencies against one another algorithmically.
DEXs are typically created using open-source software, allowing anyone with an interest to see precisely how they operate. That also implies that developers can update existing code to develop new competitor projects.
Advantages of using DEXs
The following are a few of the common benefits you may find with practically every inclusion in a decentralized exchange list.
A DEX, or decentralized exchange, stands apart because user funds are not under its control. Contrarily, traders have control of their money and can deal with the DEX as they like. The traders in a DEX transaction should be less vulnerable to a hack because all of the funds are kept in the traders’ respective wallets.
On a DEX, the anonymity of the users is kept when exchanging one crypto for another. Unlike centralized exchanges, they don’t need to provide any identification verification like personal information in a KYC process.
Reduces the counterparty risk
Counterparty risk occurs when there are any defaults in the contractual obligations, especially when a certain party involved in a transaction fails to fulfill its part of the deal. This type of risk is eliminated since DEX is operated without any interference from a third party and is solely based on smart contracts.
What are the best-decentralized exchanges?
Here is a list of decentralized exchanges that are dominating the crypto space at present according to their trading volume and market share of DeFi markets.
|Decentralized exchange||Trading volume (as of July 15, 2022)|
Despite being in their infancy, decentralized exchanges hold strong potential for changing how the financial markets work.
A cryptocurrency exchange is typically required when looking to trade cryptocurrencies. Binocs is a platform that helps by offering an overview of all your crypto-related transactions from different exchanges in one place. Binocs also helps in calculating taxes regarding crypto trading in India. Visit Binocs for more details.
Frequently Asked Questions
1. What are the three types of crypto exchanges?
Centralized, decentralized, and hybrid crypto exchanges are the three types of exchanges for crypto transactions.
2. Are decentralized exchanges safe for transactions?
Decentralized exchanges are safe in terms of preserving users’ personal data, funds, and privacy.
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