Decentralized Exchange is directly opposite to traditional banking structure, presenting users with a peer-to-peer financial platform through self-executing smart contracts.
While Decentralized Finance substitutes the traditional financial system and provides a trustless ecosystem for financial activities, DEX performs the cardinal function of facilitating the sophisticated transfer of financial assets, like cryptocurrencies, thriving on a permissionless system.
What is Decentralized Exchange
Flowing from the introduction of blockchain is the widespread adoption of cryptocurrencies. These two technologies were developed to provide users with a proper decentralized financial system without requiring a trusted intermediary.
To proffer crypto transactions, there is a need for an exchange where traders can seamlessly carry out transactions. Hence, a Decentralized Exchange can be slightly compared to a bank without the necessary meddling with user transactions.
How does it work?
Decentralized Exchange adopts two leading features of blockchain to facilitate transactions.
The first is traceability. Every transaction on a blockchain is independently recorded and can be traced from when the first block was created. The open-source blockchain makes traceability even more accessible; market participants can trace financial transactions without needing a generated statement of account, as we have in the traditional system.
Anonymity is another feature of blockchain adopted by DEX to facilitate seamless yet protected crypto exchange. This feature captures the ability of users to trade and complete transactions without revealing any of their details, not even an email address. Hence, anyone across the border can carry out bulk or small transactions without disclosing their identity details.
DEX Structures Explained
Decentralized Exchange operates differently depending on the tech structure adopted. While there are notable differences between the structures, it is vital to note that they are all dedicated to facilitating permissionless transactions on immutable blockchains.
There are three main DEX structures: AMM, OrderBook, and Dex Aggregator.
AMM (Automated Market Maker)
Decentralized Exchanges with an AMM (Automated Market Maker) structure like Uniswap, PancakeSwap and Curve rely on self-executing smart contracts and liquidity pools to facilitate trading. Hence, a sufficient liquidity pool replaces the matching of traders to provide seamless transactions on the DEXs.
Another notable feature of AMM and DEX is its price control system. Ample liquidity and automated transactions allow users to transact expediently while the system relies mainly on information from different exchanges to determine prices and maintain healthy price movement.
While some DEXes rely on AMM, some adopt on-chain or off-chain orderbook to facilitate transactions. This refers to a record of all open orders where buying and selling crypto assets is possible, and the history of these transactions is used to determine asset prices and demand and supply trends.
While DEXs with this feature share a notable similarity with Centralized Exchange, it is crucial to understand that asset ownership and control remain extensive with the users. An excellent example of a DEX operating with an orderbook is dYdX.
Decentralized Exchange with the Aggregator structure operates on multiple mechanisms and protocols to offer a more efficient financial system. For instance, the exchanges often rely on a large liquidity pool of Centralized platforms. Similarly, transactions and liquidity on other DEXs are optimally leveraged by DEX Aggregators to reduce slippage and trading fees while facilitating large orders.
Again, the fact that most DEX Aggregators rely on centralized platforms’ liquidity pool does not affect its truly decentralized nature. OpenOcean is an example of a DEX aggregator with over $24 Million 24 hours trading volume at the time of writing according to CoinMarketCap.
How to use
Step 1: Create a cryptocurrency wallet
Step2: Fund your wallet with sufficient native tokens for transaction
Step 3: Open the DEX website
Step 4: Connect wallet to DEX interface
While CEX operates on an internal matching engine and a central database, DEX operates a decentralized peer-to-peer structure to facilitate transactions. Some of the growing concerns regarding DEX are the network gas fee and slippage. Every transaction comes at a price, and on some blockchain, you pay higher. Also, large orders are often faced with slippage due to low liquidity.
In conclusion, notwithstanding the above mentioned concerns, Decentralized Exchanges has proven to be a leading force in the development and adoption of Decentralized Finance. Paving the way for fast and traceless financial transactions, DEX is more than a simple financial structure, it is one that captures the users’ need for a more transparent and truly decentralized financial system that puts users in charge of their assets.