Decentralized Exchange: Everything to Know
By Beluga Research July 12, 2023
- A decentralized exchange (DEX) is a peer-to-peer platform for cryptocurrency exchange
- It is not operated by a single, central authority.
- A DEX is more transparent, secure, and resistant to censorship than a centralized exchange
- A decentralized exchange allows peers to exchange cryptocurrencies with one another
A decentralized exchange (DEX) is a platform for cryptocurrency exchange that operates on a peer-to-peer network. Such an exchange constitutes a platform that allows users to buy, sell and trade cryptocurrencies without the need for one or more intermediaries. Decentralized exchanges operate on a peer-to-peer network, in which users retain full control over funds.
Decentralized exchanges can be more secure than centralized exchanges because they do not rely on a central authority to manage user funds. They can also be more transparent, as all transactions are publicly visible on the blockchain. In addition, decentralized exchanges have resistance to censorship. It's hard to shut them down by a central authority.
A Brief History
It was not until 2016 that decentralized exchanges gained popularity with the launch of the Ethereum blockchain. The Ethereum blockchain enabled the creation of smart contracts. These are self-executing contracts in which the terms of the agreement between buyer and seller are written into the lines of code.
The first decentralized exchange to use smart contracts was EtherDelta, launched in 2016. EtherDelta allowed users to trade Ethereum-based tokens without the need for a central authority. Since then, many other decentralized exchanges have been launched, including UniSwap, SushiSwap and PancakeSwap - among many others.
What Is a Decentralized Exchange?
A decentralized exchange is a cryptocurrency exchange that operates on a peer-to-peer network. Decentralized exchanges use smart contracts to automatically execute trades between buyers and sellers.
In a decentralized exchange, users can trade cryptocurrencies directly with each other. When a user wants to make a trade, they connect their cryptocurrency wallet to the exchange. This allows the user to manage their funds directly. It ensures that the exchange cannot access or control their funds.
- Have a cryptocurrency wallet . The wallet must support the tokens the users want to trade. Decentralized exchanges are unlike centralized exchanges in that they do not require users to create an account or provide personal information.
- Connect the wallet to the platform . This allows the user to start trading. Not all cryptocurrencies are available on all platforms. Users need to ensure that the platform they choose supports the tokens they want to trade.
- Trade by placing orders . The trades are accomplished through smart contracts. This enables users to remain in control of funds at all times.
- Choose between a limit order and a market order . A limit order allows a user to set a specific price for a trade. A market order executes the trade at the current market price.
- Get familiar with the platform . Decentralized exchanges are not as user-friendly as centralized exchanges. A user may need to spend some time getting familiar with the platform.
- Not controlled by any central authority . A decentralized exchange cannot easily be shut down or censored. This is in contrast to centralized exchanges, which are vulnerable to hacking, government regulations and other external factors.
- Offer greater privacy and security . Users do not need to provide personal information to use the platform.
- Allows for peer-to-peer trading . Users can trade directly with each other without the need for intermediaries. This eliminates the need for order books and reduces the risk of front-running and other forms of market manipulation.
- Offer greater transparency . All transactions are recorded on the blockchain and can be easily audited.
- Offer greater liquidity . Users from all over the world can participate in the platform. This means users can access a larger pool of buyers and sellers. This can result in better prices and faster execution times.
- Offer greater flexibility . Users can trade any amount of cryptocurrency without being subject to minimum or maximum trade sizes.
- Transparency . Decentralized exchanges are transparent because all transactions are recorded on a public blockchain network. Users can verify the authenticity of transactions and ensure no fraudulent activity is taking place.
- Security . A DEX is more secure than centralized exchanges. They do not store users' funds in a central location. Instead, users have full control over private keys. The private keys are needed to access the funds. The set-up of a DEX makes it difficult for hackers to steal funds. Bad actors would need access to each user's private keys.
- No Know Your Customer (KYC) . Decentralized exchanges do not require KYC verification. Users can trade cryptocurrencies without revealing their identity. This provides them with greater privacy and anonymity.
- No central authority . Decentralized exchanges do not have a central authority that controls the exchange. There is no single point of failure. The exchange cannot be shut down by a single entity.
- No downtime . A DEX is always available. They operate on a decentralized network. Users can trade cryptocurrencies 24/7 without any downtime.
- More accessible . Decentralized exchanges are more accessible than centralized exchanges. They do not require users to go through a complex registration process nor provide personal information.
- Limited liquidity . Decentralized exchanges have limited liquidity compared to centralized exchanges. There are fewer users on a DEX, resulting in fewer buyers and sellers on the exchange. The lower liquidity can result in lower trading volumes and higher spreads.
- Slow transaction speed . Transactions on a DEX can be slower than on a centralized exchange. Transactions need to be processed on a blockchain network. This can take longer than on a centralized system.
- Limited trading pairs . Decentralized exchanges have a limited number of trading pairs compared to centralized exchanges. Not all cryptocurrencies are compatible. It can be challenging to create trading pairs for all cryptocurrencies.
- Lack of customer support . Decentralized exchanges do not have a customer support teams to help users with their issues. Users must utilize forums and communities to get help.
- Higher learning curve . Decentralized exchanges can be more challenging to use than centralized exchanges. The decentralized exchanges require users to have a basic understanding of blockchain technology and methods of using a cryptocurrency wallet.