Understanding Decentralized Exchanges: What Are They And How Do They Work?

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Cryptocurrencies are becoming more popular. With this, more people want to join the cryptocurrency market. 

One of the best ways to do this is by buying cryptocurrencies on a decentralized exchange.

Decentralized exchanges are different from centralized exchanges account. The prior doesn’t require users to deposit their funds into a third-party account. 

This makes them much more secure. Hackers can’t steal your funds due to this. In this blog post, we will look at some of the best-decentralized exchanges currently available.

Decentralized Exchanges Defined

Decentralized exchanges are digital assets. They do not depend on a third party to hold or manage customers’ money. 

Instead, they trade directly between users on a decentralized network. This type of crypto is safer.

It is also more resistant to hacks than traditional centralized crypto exchanges.

Some popular decentralized exchanges include IDEX, EtherDelta, and Binance DEX. 

These platforms typically allow for more customization. It also allows advanced trading volume than centralized exchanges. But it can be less user-friendly.

Decentralized exchanges aim to solve traditional exchanges problems. This includes hacks, fraud, and regulatory compliance. 

Unlike centralized exchanges, decentralized exchanges are more secure. 

They also offer several advantages in terms of transparency and fund control.

Decentralized exchanges have become increasingly popular as the cryptocurrency industry has grown. 

Many see them as a more secure and resilient way to trade digital assets. This is especially true in high-profile hacks at centralized exchanges.

Evolution of Decentralized Exchange

Decentralized exchanges were a response to the centralized exchanges. 

Centralized exchanges are convenient. But they come with several drawbacks. They are vulnerable to hacks. And insiders can easily manipulate them too.

Decentralized exchanges aim to solve these problems. This is possible by distributing themselves across a network of computers. This makes them more resistant to licensing and shutdowns. 

They are also generally less vulnerable to hacks. This is because there is no central point of failure.

However, decentralized exchanges have risks too. They can be difficult to use. Often, they have low liquidity too.

But as technology advances, these problems have been slowly but surely addressed.

Today, there are some popular decentralized exchanges with high liquidity and easy-to-use interfaces. 

The most well-known example is probably Ethereum’s decentralized exchange, EtherDelta. However, there are many other excellent decentralized exchanges. This includes Waves DEX, Bancor Network, and Kyber Network.

How A Decentralized Exchange Works

Here are three main types of decentralized exchanges and their similarity:

Automated market makers (AMMs)

These platforms use smart contracts to trade digital assets. Algorithms set the prices instead of order books.

People who want to sell their assets can put them into a pool. In exchange, they will have to pay a fee. This will help to provide liquidity for the people in the pool. Uniswap, Bancor, and Balancer are examples of popular AMMs.

Here are some decentralized exchanges under AMM:

  • Uniswap – It is a decentralized protocol on the Ethereum blockchain. It allows anyone to swap ETH and ERC20 tokens easily.
  • Bancor – Bancor Protocol is a way to create Smart Tokens™. Additionally, this is needed so that different cryptocurrencies can be directly converted through their smart contracts. So, there is no need for two parties to meet in an exchange.
  • Curve – Curve is a decentralized finance protocol on Ethereum. In addition, it also allows users to trade ERC20 tokens with low slippage. You can do this by combining tokens to form one liquidity pool, which then trades as a synthetic asset called a CRV token. This makes it easier for people to trade different types of tokens without having to move them to different exchanges.
  • SushiSwap – SushiSwap is a modified version of the UniSwap protocol. It was created as an experiment to see how the community could govern itself. With this, it has become a fully decentralized autonomous organization.
  • Kyber Network – Kyber Network is a protocol that helps with liquidity. This means it brings together a lot of different places where people can buy and sell tokens. Kyber also makes sure that the trades between these places happen safely.
  • Gnosis – Gnosis is a platform that helps apps predict real-world events better. It does this by getting predictions from lots of people, then giving rewards to the people who were most accurate.

Order book exchanges

These platforms match buy and sell orders from users. The orders are put in a list, similar to how it is done on a traditional centralized exchange. The difference is that this happens on a blockchain. The trades happen between users, too (peer-to-peer).

Here are some decentralized exchanges under Order book exchanges:

  • dYdX – dYdX is a decentralized platform for trading crypto assets. It offers margin trading, lending, and borrowing of digital assets.
  • Nash Exchange – Nash is a decentralized exchange. It allows users to trade digital assets without depositing them into the exchange.
  • Tomo DEX – TomoChain’s decentralized exchange is built on the TomoChain platform with high speed and low cost.
  • ViteX – ViteX is a decentralized exchange built on the Vite platform. It offers trading of digital assets with low fees and high speed.
  • Binance DEX – Binance DEX is a decentralized exchange built on the Binance Chain blockchain. It allows for the trading of digital assets with high speed and low fees.
  • DDEX – DDEX is a decentralized exchange built on the Ethereum blockchain. It offers trading of digital assets with low fees and high speed.

DEX aggregators

These platforms act as a portal to multiple decentralized exchanges. It allows users to trade on multiple platforms from one interface. In addition, they often provide features such as order books and charting tools.

Some popular dex aggregators are:

  • 1inch Exchange – 1inch is a decentralized exchange aggregator. It allows users to trade on multiple platforms from one interface. It also provides features such as an order book and charting tools.
  • DeversiFi – DeversiFi is a decentralized exchange aggregator. It provides features such as an order book and charting tools.

Advantages of using a DEX

The costs of trading on cryptocurrency exchanges can be high. This is especially true if the network transaction fees are high during trading. However, there are many benefits to using DEX platforms.

Tokens Availability

Centralized exchanges have to check tokens individually. This is to ensure that they meet local laws before being listed.

Decentralized exchanges can include any token made on the blockchain.

This means that new projects will likely be available on these exchanges before they are available on their centralized counterparts.

Anonymity

When people trade one cryptocurrency for another on DEXs, their anonymity is safe. There is no standard “Know Your Customer” process that people on decentralized exchanges have to go through to get money.

KYC processes collect traders’ personal information. This includes their full legal name and a picture of their government-issued ID.

A lot of people want to be anonymous on DEXs.

Security risks are lesser.

Cryptocurrency users who keep their own money are less likely to be hacked when using DEXs. This is because these exchanges don’t have control over their money.

Instead, traders keep their money and only use the exchange when they want to. If hacked, only the people who buy and sell money could be at risk.

Reduced risk for the other party

Counterparty risk happens when the other party in a deal doesn’t do what they agreed to do. In addition, they don’t keep their end of the deal.

Because decentralized exchanges don’t have any middlemen and use smart contracts, this risk isn’t there.

People who use DEXs can quickly search the web to see if the exchange’s smart contracts have been audited. They can then make decisions based on other traders’ experiences.

Disadvantages of using DEXs

Knowledge is essential.

DEXs can be used by cryptocurrency wallet holders. This is possible as long as their wallets have a smart contract feature. You must not only know how to use digital wallets. Instead, they also need to have security principles linked with keeping their assets safe.

Smart contract flaws

Smart contracts on Ethereum and other blockchains are open sources. Moreover, trustworthy businesses inspect huge decentralized exchanges’ smart contracts.

It’s human to err. So exploitable flaws may evade audits and code inspections. Auditors may not know that there are new attacks. This could penalize liquidity providers’ with their tokens.

Unverified Tokens

Anyone may come up with a new token. On a decentralized exchange, they may pair it with other currencies. As a result, investors are exposed to scams such as rug pulls. Rug convinces them to buy a different token.

Several DEXs addresses these problems by demanding users to verify the smart contracts of the coins. For seasoned players, this method works, but not for others.

Decentralized Exchanges vs. Centralized Exchanges

Exchanges facilitate stock trades worth billions of dollars in the worldwide cryptocurrency industry.

Major exchange platforms are responding to the rising popularity of digital currencies. They provide property storage, new trading products, and services. In addition, they also provide more access to electronic commodities.

DEXs have gained popularity with the conventional centralized exchange. This results from the cryptocurrency industry’s focus on decentralization.

Decentralized exchanges perform without a third party for checking deals. Instead, they depend on self-executing smart contracts to support transactions. Decentralized crypto exchanges have a slower response time and higher transaction fees.

Without these parties, DEXs become non-custodial. This means you own your cryptocurrencies and are in charge of your wallets and private keys.

Keeping your private keys is a plus.

However, if your keys are lost, stolen, or destroyed, no one will be able to access them. Unless they know your password.

Due to the absence of an intermediary, most DEXs are safer. They are also exempted from KYC and AML regulations.

There is segmentation in the growing DEX market. Hence, offering new and experimental financial products requires platforms to incorporate order books.

Also, liquidity pools and other decentralized finance (DeFi) processes are required.

Conclusion

Decentralized exchanges are the future of cryptocurrency trading. They offer more security, privacy, and freedom than their centralized counterparts.

It also allows for a greater degree of control over one’s funds. More people are becoming aware of the benefits of decentralized exchanges. As a result, their popularity will likely continue to grow in the years to come.

Have you tried using a decentralized exchange? If not, why not give one a try?

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