Decentralized exchanges have been making a name for themselves in recent years and some investors may be left wondering what they even are in the first place. A decentralized exchange, or DEX as it’s more commonly referred to, is a cryptocurrency exchange that facilitates direct, peer-to-peer crypto transactions without any middleman. Decentralized exchanges are important due to their relevance in the decentralized finance (DeFi) ecosystem.
To wrap your head around the concept of decentralized exchanges, you must first understand why cryptocurrency exchanges exist in the first place.
Let’s warp backwards to 2009, when the world was first introduced to cryptocurrency in the form of Bitcoin, since the first conception, crypto exchanges have played a vital role in making Bitcoin and other crypto assets accessible to everyone. Typically, a crypto exchange matches buyers and sellers and gets them to agree on the correct price of the assets, usually by supply and demand.
As a normal investor, purchasing and selling crypto assets was almost impossible without first registering with a crypto exchange of some type. The controlled exchange was the first point of entry for anybody interested in the cryptocurrency ecosystem.
As technology advanced, a plethora of decentralised trading tools and platforms arose to remove the need for middlemen.
The objective of decentralised exchanges is to enable transactions without expressly requiring consumers to place their trust in facilitators. In summary, you are not required to trust or mistrust the platform that enables decentralised, peer-to-peer transactions, since no centralised organisation holds your cash.
Decentralized vs Centralized When It Comes to an Exchange?
There are several fundamental contrasts between decentralised and centralised exchanges. Before we can comprehend how a decentralised exchange works, it is necessary to understand how it differs from its centralised, traditional counterpart.
To begin, the key distinction between decentralised and centralised exchanges is that a centralised exchange requires you to register and validate your account.
You cannot trade crypto assets without first registering with a controlled exchange. On the other side, decentralised exchanges do not need users to register in order to conduct trades.
Decentralized exchanges enable direct transactions between two non-custodial wallets with little or no assistance from a third party.
In contrast to centralised exchanges, decentralised exchanges enable direct transaction between two users.
In a centralised cryptocurrency exchange, the majority of power over your account is retained by the third party that operates the exchange. On the other hand, with a decentralised exchange, you retain complete control over your account.
This is another significant factor for the rise in popularity of decentralised exchanges. However, it is equally to blame for the increased complexity of such systems.
How a decentralized exchange works
The Order Book concept is used to manage trade on centralised exchanges, where buyers and sellers place orders. While customers want the lowest feasible price for an item, sellers desire the most profit margin possible. Prior to the transaction taking place, the buyer and seller must agree on a price.
Each asset swap on a decentralised exchange, such as Uniswap, is backed by smart contracts that serve as a trusted escrow and govern activities inside the liquidity pool.
Having said that, decentralised exchanges such as Uniswap seek to minimise their dependency on external market makers in order to keep transactions quick and economical. Additionally, decentralised exchanges integrate with non-custodial wallets like as MetaMask, allowing traders to maintain control of their funds.
Advantages of a decentralized exchange
There are many advantages to a decentralized exchange, some of them are not listed here but let’s dive into the most important ones that a lot of people believe to be the best.
One of the most obvious advantages of a decentralised exchange is the elimination of intermediaries and the ability to conduct peer-to-peer transactions without the intervention of central authority.
Decentralized exchanges minimise counterparty risk by limiting trades to two users. As a consequence, users are not concerned about their cash being stolen by other parties.
Decentralised Exchanges Have Limits
Just like anything in life, decentralized exchanges aren’t perfect. Since they are a new(ish) concept on the crypto market, they come with their drawbacks, as the technology advances though, it’s imagined that these will subsidise.
A significant disadvantage of the majority of decentralised exchanges is their lack of functionality in comparison to centralised exchanges. As decentralisation technologies advance, we may anticipate a larger selection of goods and functionalities on decentralised exchanges.
Transaction fees and speed
Due to the fact that decentralised exchanges operate on a blockchain network, transactions may be delayed and costly when the network is overloaded.
There is no doubt that the crypto industry is evolving toward a more automated and simplified trading experience. Numerous decentralised exchanges have developed in the recent year, attempting to eliminate intermediaries in exchange for more privacy and security. However, decentralisation in general is still in its infancy, and we anticipate the emergence of further decentralised tools and platforms in the near future.