Do you know what DEX means? Let’s explore DEX together.
DEX is the abbreviation for Decentralized Exchange, the opposite of Centralized Exchange (CEX). Centralized Exchanges include Binance, Coinbase, or Kraken, and customers can only buy and sell cryptocurrencies on them. You can think of these as crypto banks.
Decentralized Exchanges are protocols like Uniswap, 1inch, Pancakeswap, and Quickswap. Unlike CEX with order books, DEXs function through liquidity pools, supplied by liquidity-rewarded providers who are then rewarded with a cut of fees. Everything is executed on a blockchain using smart contracts with no middlemen.
Some of the benefits of DEXs include More privacy as you don’t have to go through KYC verification unlike CEX, just a wallet address is needed. Security as you remain in control of your private keys. No centralized control or single point of failure as DEX governance is decided by token-holders.
How does a DEX work?
Dexs are a set of smart contracts that execute trades on-chain. Users can connect their self-custody wallet to a DEX, and start trading thousands of tokens, without signing up or sharing personal information. DEX transactions don’t require any third parties to execute. You will find many blockchains with DEXs, among all DEXs built on Ethereum are most popular.
Now you may learn about DEX and you might have a question in your mind why should I use a DEX? And here is the answer.
1. Accessibility
You can simply access DEX via your smartphone with an internet connection. As we already discussed, DEXs are open-source and are built on blockchains, these are more accessible and are often not available on centralized exchanges by governments.
2. Privacy
If you are using a centralized exchange, you need to register and send sensitive information, such as government identification numbers and bank account information to these centralized entities. But in DEX, you only need to connect your self-custody wallet, which means, there is absolutely no risk of personal data being misused or stolen.
Ensures more control over your crypto. Inj crypto, to access the self-custody wallet, you need to use a private key, which simply means a password. Crypto in a self-custody wallet on a decentralized exchange means you have complete control over the crypto.
3. Cheaper and more transparent trades
Trades made using centralized exchange might impose paying fees that can be as high as 3.99%, while at DEXes it is comparatively low. On most of the trades using Matcha, 0x Lab’s DEX aggregator, fees are literally zero. The popular DEX and Uniswap trade fees are just 0.3%. Since DEX order books are transparently recorded on the blockchain, it effectively reduces the risk of falsified prices or trade volume manipulation.
Key Features and Principles of DEX
Non-custodial: Using DEX, users can retain control of their private keys and assets throughout the trading process. Asset loss that can be caused by hacks or exchange failures is eliminated.
Peer-to-Peer Trading: Buyers and sellers are connected directly which enables the trade of cryptocurrencies without relying on a central authority.
Trustless Transactions: DEXs leverage smart contracts to automate trade settlements and asset transfers. Blockchain technology assures that there is no need for trust or a third party.
Democratized Access: The majority of the DEX can be accessed by anyone with an internet connection and a compatible wallet to participate in trading activities.
How to Use a DEX?
A sign-up is not necessary to use DEX. Users essentially need not have an email address to interact with DEX. you only need to have a wallet that is compatible with the smart contracts on the network of the exchange. Follow the below-given steps to use a DEX.
Step 1: Choose a network to use as a transaction fee is incurred on every trade.
Step 2: Choose a wallet that is compatible with the selected network.
Step 3: Fund the wallet with tokens. Tokens can be purchased from CEX. This can be identified easily via the ticker symbol they use.
After buying the tokens, withdraw them to the wallets you control.
Make sure the fund is not moved to the wrong network. With a funded wallet, click on the ‘Connect Wallet’ facilitated on the web portal of DEX or connect the wallet through a pop-up prompt.
Types of Decentralized Exchanges
Automated market makers (AMMs)
AMM stands for Automated Market Maker and essentially fully decentralized trading mechanisms that use algorithms and liquidity pools to price and execute trades without traditional order books. Examples of AMM include Uniswap, which is one of the largest decentralized exchanges in the space. Liquidity pools have formulas that enable two assets that you provide into the pool to be stable.
Order book DEXs
This compiles records of all open orders to buy and sell assets for specific asset pairs. There are two types of order book:
- On-chain order: This type of exchange may permit traders to leverage their positions using funds borrowed from lenders on their platform. Leveraged trading increases the earning potential of a trade, but it also increases the risk of liquefaction as it enhances the size of the position with borrowed funds, which have to be repaid even if the traders lose their bet.
- Off-chain order: Helps exchanges lower costs and raise speed to guarantee that trades are executed at the prices desired by the users.
DEX aggregators
DEX aggregators combine the liquidity from a range of different decentralized exchanges and therefore they offer particular advantages. It means that you can rest assured knowing that you are getting the best exchange rate possible out of a range of different DEXs. Most offer smart routing algorithms so it will perform and execute the trade in the most efficient way possible and you still get to keep full custody of your assets.
Pros and cons of using DEX
Pros
- Token availability
- Anonymity
- Reduced security risks
- Reduced counterparty risks
Cons
- Specific knowledge is required
- Smart contract vulnerabilities
- Unvetted token listings
FAQs
- What does DEX stand for?
DEX stands for Decentralized Exchange.
- Are DEXs regulated?
The regulatory status of DEXs varies depending on the jurisdiction. Some countries have implemented strict measures or outright ban on their use.
- How to choose the right DEX?
Choosing the right DEX depends on the trading needs and preferences. Some factors considered while choosing are trading mechanism, liquidity, fees, user experience, and security.