What is a DEX and How Does it Work?

What is DEX and How does it works

Over the past few years, the DeFi and NFT markets have taken a big leap in development. TVL volumes in these markets continue to grow every year. Decentralized platforms have played a huge role in the development of the DeFi market as a competitor to the classical financial system.

The structure of management, trading and making a profit on the DEX is significantly different from the centralized platforms familiar to the entire financial world. The DeFi and DEX market is developing so rapidly that many users do not have time to get the necessary information and answer questions such as: what is a decentralized exchange and what is the difference between centralized and decentralized platforms. 

In this article, we will talk in detail about decentralized platforms and try to reveal all the secrets of trading on DEXs as accessible as possible.

What is a Decentralized Exchange?

Let’s start with a simple question: What are DEXs at all? Decentralized exchanges (DEX) are DeFi platforms which use blockchain technologies and networks for allowing users to make crypto operations. They do not have any governing body and do not control users’ funds.

Okay, that’s clear. But what exactly is DEX in crypto and how does it work? DEXs are managed either automatically using smart contracts, or semi-automatically, that is, with the involvement of developers and assistance from the community. The functionality of the decentralized exchange is designed to match requests for the purchase/sale of digital assets. In addition, some exchanges have implemented the possibility of staking and farming as well.

The most popular DeFi blockchain network is Ethereum. Due to the high commissions on the Ethereum network, exchanges operating on the BNB Smart Chain network are becoming increasingly popular. Exchanges operating on the Ethereum network work with ETH itself and ERC-20 tokens. The exchanges in the BSC network support the BEP-20 standard.

Centralized Exchange in Crypto

CEX is an exchange managed from a single center. The exchange administration is responsible for overseeing exchange operations, ensuring the security of funds, and maintaining the system. These exchanges include Binance, Coinbase, Kraken, Houbi, and others. 

Among the main advantages of CEX is the ability to work with fiat funds, which significantly expands the audience of such platforms. Due to its consistent and huge liquidity reserves, CEX is well known for its extensive functionality for spot and margin trading.

CEX is strictly regulated by the laws of specific countries, and therefore users do not have access to private keys, and there are also security risks due to a hacker attack. Manipulation of token prices for profit is particularly widespread on the CEX. Furthermore, in order to trade on centralized platforms, you must go through the KYC process and have your identity verified.

Decentralized Exchange and How Is It Different?

Before we find out what decentralized crypto exchange is and how it differs we need to know more about classical exchanges. We need to know that CEX is traditional exchange that have a management that is responsible for the confidential data of users. The site stores the history of trading controls the work of the exchange and single-handedly makes all decisions on the development of the project.

  • Decentralized exchanges (DEXs) do not have a single governing body as such. Exchanges are managed in automatic or semi-automatic ways. With semi-automatic management, decisions about the development of the project are made by developers together with the community.
  • An important difference between DEX and CEX is the use of an automated market-making protocol by decentralized platforms. This method allows you to determine the price of an asset algorithmically with the help of a save function. CEXs use an order book where the trades of all users are stored.
  • A user needs to perform a minimum of actions in order to trade on DeFi. Just connect your wallet. However, security suffers, and DEX does not guarantee the safety of your coins.
  • When trading on a DeFi, a trading process is going person to person directly. And they only pay for transactions. The commission amount is dynamic and is determined by the amount of traffic on the blockchain. There are no additional commissions charged by intermediaries between them. Therefore, in theory, the commission on decentralized exchanges is less than on centralized ones. In practice, the commission level can be quite high because of a high load on the blockchain network.

Pros of DEX

  • Anonymity: registration and KYC is not required;
  • Security of funds: a DEX does not store user funds, so there are no financial risks in the event of a hacker attack or the collapse of the exchange;
  • Lack of a single point of entry: working on the basis of a distributed ledger deprives hackers of the possibility of hacking and makes the attack meaningless.

Cons of DEX

  • Limited functionality: lack of margin trading, the ability to set Stop-Loss, etc;
  • Low liquidity: the liquidity pool is smaller than on centralized exchanges, so the likelihood of slippage is high;
  • Lack of support: no single management, no technical support.

It is important to note that the non-participation of developers in the listing of tokens on decentralized exchanges sometimes leads to the spread of counterfeit tokens. It is extremely important to check the information about the project on ScammerWatch before trading tokens. This will help to avoid scam projects and fraudulent schemes, which are very common in the Defi sector.

Protection Against Malicious Crypto Trading Practices 

DEXs have gained great popularity, among other things, due to anonymity and increased decentralization. However, this is not quite true. DeFi projects have several strong aspects of centralization. We are talking about price oracles, the existence of “administrator keys” and smart contracts. All of this could be a potential target for a hacker assault.

DEXs do not have the ability to recover lost or stolen funds. Due to the lack of a KYC process or the ability to reverse a transaction, users are unable to recover data or recover their assets. All transactions are processed and stored in smart contracts on the blockchain without any owners or controllers, and therefore refunds are usually not possible.

DEXs fight these vulnerabilities by using smart contracts and giving users full control over their funds. Users do not need to transfer their assets to the exchange, and therefore DEXs can reduce the risk of theft and loss of funds due to hacking. DEXs can also prevent price manipulation or fake trading volume. Due to this, the risks of hacking, exploit or other hacker penetrations are minimized and largely depend on the user and his actions.

Best Decentralized Exchanges

According to the ranking of DeFi exchanges by CoinMarketCap and CoinGecko, the top DEXs are Uniswap and PancakeSwap.

UNISWAP

Uniswap is a financial protocol used to exchange digital currency. Uniswap is also the name of the company that originally developed this protocol. The protocol facilitates automatic transactions between crypto-assets tokens on the Ethereum blockchain through the use of smart contracts.

PancakeSwap

PancakeSwap is a DEXe on BNB Chain that uses the automatic market maker (AMM) model. This means that although you can trade digital assets on the platform, there is no order book in which your order is compared to another. Instead, you trade against a liquidity pool.

SushiSwap

SushiSwap is a unique crypto exchange that has revolutionized the DeFi platform and surpassed PancakeSwap in many ways. On the platform, users can exchange digital coins, as well as use unique passive and active earning mechanisms.

1inch 

1inch is a unique cryptocurrency platform built on decentralized mechanisms and protocols. The crypto exchange algorithms are based on the analysis and search for the most profitable offers for users in terms of investment and profitability.

Curve Finance

Curve Finance (CRV) is another unique representative of the decentralized finance market, which focuses on more stable and less volatile assets. In other words, it is a complete platform focused on stablecoins and their exchange.

When choosing a DEX to trade, it is best to rely on trading volumes to ensure that the required level of liquidity is available. Up-to-date information on trading volumes can always be found on the CoinMarketCap and CoinGecko websites.

Also Read: What is Yield Farming? How Does it Work?

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