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Decentralized exchange or DEX is a peer-to-peer market and trading platform where users can exchange digital currencies on a peer-to-peer basis without the need for an intermediary. Transactions in Dex exchange are executed through the use of smart contracts. DEXs were created to eliminate the need for any intermediary to monitor and control transactions made on an exchange. In fact, decentralized exchanges enable peer-to-peer (P2P) transactions of cryptocurrencies; These types of transactions include a market that connects buyers and sellers of cryptocurrencies without intermediaries.
Dex Trading is actually trading activities carried out in decentralized exchanges. In decentralized exchanges, it is possible to trade digital currencies directly on the blockchain networks without trusting any intermediary centralized entity. dex trade exchange does not require identity verification (KYC) for Iranians and users can trade digital currency anonymously anywhere in the world. In the rest of this article, I will discuss more about what decentralized exchange is and the reasons for its popularity.
What is DEX or decentralized exchange?
Decentralized exchanges, also commonly known as DEX, are a peer-to-peer (P2P) marketplace that allow users to buy and sell cryptocurrencies without leaving capital management to intermediaries. DEX actually stands for Decentralized Exchange. Decentralized exchanges have made it possible to eliminate intermediaries with blockchain, and transactions are recorded in them using coded agreements called smart contracts.
Decentralized exchange (DEX) has been created to eliminate the rules and requirements of various organizations and institutions in licensing and monitoring for conducting transactions in the cryptocurrency market. These exchanges have also provided users with the possibility of trading currency pairs.
In this type of investment, each of the parties to the transaction has a private key to access the capital in their digital currency wallet, and they are able to access their account balance immediately after logging into the exchange user account using this key.
In this situation, people no longer need to provide personal information such as residence, name, etc.; Unless authentication is mandatory in the desired exchange. In general, the definition of decentralized exchange (DEX) can be defined as the functioning of these exchanges in a decentralized manner without the intervention of any controlling authority.
It should be noted that in these exchanges, it is not possible to conduct transactions based on fiat currency such as Rial or Dollar. Thus, to start, you must first buy digital currency in a centralized exchange using fiat money, and then use DEXs.
How Decentralized Exchanges (DEX) Work
Due to the fact that decentralized exchanges or DEXs are created on blockchain networks and layer one protocol, they will support smart contracts. In this type of exchange, users themselves are the guardians of their funds. Doing any transaction in DEX requires payment of fees; Basically, traders or traders have some kind of interaction in the blockchain network to use a decentralized exchange with a smart contract.
In general, there are three types of decentralized exchanges, which I will discuss below:
- Automated Market Makers (AMMs)
- Order Book DEXs
- DEX Aggregators
All three types of Dex above allow users to trade with each other directly through smart contracts. Decentralized exchange of the order book type is used in the same way as centralized exchanges.
Automated market maker
One of the most popular types of decentralized exchanges, or DEXs, are automated market makers (AMMs), which use a liquidity pool instead of an order book. In this case, the rate of cryptocurrencies is determined not by buyers and sellers or institutions, but by a smart contract.
Even for markets with low trading volume, liquidity is high in the automated market maker, and buyers and sellers do not need to wait for orders to be placed. The price of tokens in the algorithm of this structure is determined based on the increase and decrease of their ratio in the pools, thus creating an opportunity for arbitrage.
Decentralized exchange with order book (DEX order book)
Order books are responsible for collecting and maintaining records of open orders for wallet transactions. In this situation, the market price and the depth of the book are determined based on the gap between the price of the buy order and the sell order. Order offices have two types of on-chain and off-chain. In on-chain ledgers, order information is stored on the chain and users’ assets are kept in their wallets.
But in the off-chain type, there are order books outside the blockchain and they only settle the final transaction of the blockchain network. This process will reduce the costs of the blockchain network and increase the speed of activity in the exchange.
In the off-chain exchange, users use the capital they have obtained from others through a digital currency loan as leverage and strengthen their trading position in order to increase the probability of obtaining profit.
Read more: Crypto Lending
On the other hand, in the exchange of the order office within the chain, the possibility of price slippage increases with the increase of the time interval between order registration and its finalization. It should be noted that these types of exchanges also provide users with the possibility of receiving a loan and using it as leverage.
Read more: What is leverage in digital currency?
Decentralized exchange aggregating liquidity
Aggregator means collecting the amount of liquidity needed to register orders through the path of collecting several mechanisms and protocols and from different DEXs. This method reduces slippage in large transactions and optimizes the price of cryptocurrencies in the transaction process. This type of decentralized exchange has the two goals of protecting traders from the effects of pricing slippage and reducing failed transactions. It also encourages beginners to professional traders to use it by improving the user experience.
Advantages of using a decentralized exchange
Trading on DEXs or decentralized exchanges is expensive, especially if transaction fees are high. However, using DEX platforms has many advantages, which I will mention below:
Tradability of all tokens
Centralized exchanges review tokens individually to ensure they comply with local regulations before listing them. But decentralized exchanges can include any token built on the blockchain. This means that new projects are listed in these exchanges before they become available. In other words, traders have the possibility to enter these projects as soon as possible.
being anonymous
When users exchange one currency with another currency, this action is done anonymously in a decentralized exchange. In these exchanges, unlike centralized exchanges, users do not need to go through the authentication process (KYC). As a result, people who don’t want to be identified and want their transactions to be done anonymously are attracted to decentralized exchanges or DEXs.
Reducing security risks
Experienced users who exchange capital in a decentralized exchange are less likely to be hacked. Because the DEXs will not control the funds and the trader himself is obliged to protect his funds. If the platform is hacked, the only provider of liquidity may be at risk.
Reducing counterparty risk
Counterparty risk occurs when the other party to the transaction does not accept its obligations and does not complete part of the transaction. Given that the decentralized exchange is without intermediaries and based on a smart contract, this risk will not exist. To ensure that there is no risk when using DEXs, users can check the exchange’s smart contract audit by searching the web. Even these people will be able to make decisions based on the experience of other traders.
Disadvantages of using Dex or decentralized exchange
Despite the many advantages mentioned about the decentralized exchange, these DEXs also have disadvantages that are mentioned below:
Vulnerability of smart contract
Smart contracts in blockchains like Ethereum are accessible to the public and anyone can check their code. In addition, reputable companies help code security by auditing smart contracts of large databases. However, exploitable bugs will still be able to break past audits and other code reviews.
The need for knowledge when using a decentralized exchange
Dexes can be accessed by crypto wallets and interact with smart contracts. To use a decentralized exchange, users must not only know how to use these wallets, but must also understand the concepts of keeping their assets safe. Supplying these wallets is based on tokens suitable for each network. Without the main token of the network, it is possible to be locked and not to transfer other funds; Because the trader is not able to pay the fee required to transfer them. Therefore, technical knowledge is required to choose a wallet and fund the wallet with the right tokens. Without having the knowledge, traders may lose their capital by making various mistakes.
Unchecked token listings
In a decentralized exchange (DEX), anyone has the ability to list a new token and can also provide liquidity by pairing it with other coins. This can trap investors into fraud; So they think they are buying a different token. Therefore, before buying any coin, a trader should read its white paper and get more information about it. This type of accuracy will prevent common scams and Ponzi schemes in which users are abused.
