What Is A Decentralized Exchange (DEX)
Decentralized Exchanges are one of the next big things in cryptocurrency.
Considering that most cryptocurrencies use the principle of decentralization, the rise of Decentralized Exchanges (DEX) in the past months is not surprising.
Therefore, if you have plans to invest in or transact cryptocurrencies, you should know about decentralized exchanges.
In this article, we have answered a few questions you may have about DEX.
An introduction to Decentralized exchanges
A Decentralized Exchange, commonly known as DEX, is a cryptocurrency exchange where crypto transactions happen between customers.
Contrary to centralized exchanges, which have an intermediator, decentralized exchanges rely on a blockchain.
Furthermore, these exchanges use smart contracts and order book-keeping technologies to keep track of the transactions.
It also means the funds transferred through a decentralized exchange do not reach the third party.
Instead, it goes from the sender to the recipient directly.
As you can guess, decentralized exchanges are considered an alternative to centralized exchanges that currently dominate the crypto space.
Due to this approach, DEX is known for some advantages and disadvantages.
How do Centralized exchanges (CEX) work?
Here are the basic steps through which a centralized exchange works.
- If you want to buy cryptocurrency through a CEX, you have to deposit funds through fiat currencies or cryptocurrencies
- The exchange gives you the corresponding cryptocurrency assets based on how much you pay. It will transfer the cryptocurrency from its wallet to yours.
- You receive the cryptocurrency in the hot wallet or a dedicated wallet whose address you have given.
The process wants you to trust the exchange. You buy the cryptocurrency from the exchange and not another customer.
How do Decentralized exchanges (DEX) work?
On the contrary, decentralized exchanges work through the following steps.
- Suppose you have to buy Bitcoin through a decentralized exchange. You submit the request through the interface.
- The exchange will find a customer who wants to sell Bitcoin for fiat cash or another cryptocurrency. It will then match the request.
- In the third step, using smart contracts or another technology, the DEX will finalize the transaction. The seller will send the Bitcoin to a wallet the buyer has specified.
There is no central authority involved in the process. The system runs entirely on blockchain, and the steps are automated. The essence of a Decentralized Exchange is peer-to-peer transactions.
DEX Vs CEX
There are many similarities between a DEX and a CEX. For instance, as a first-time buyer, you cannot tell the difference between the two types of exchanges.
However, when you think about the control you have on the assets, the story becomes different.
When you buy or sell cryptocurrencies using a CEX, you have to transfer your fund/asset to the exchange in the first place. Then, the exchange does the transaction for you.
Because it is an intermediary service, you may have to pay a service charge in addition to the network transaction fee. A centralized exchange may also employ a KYC system to prevent money laundering and other types of fraud.
CEX is relatively easy to use as well.
However, when you use a Decentralized Exchange, you do not interact with a third-party entity. Instead, the transaction takes place between the buyer and the seller.
The exchange does the task of connecting these peers. Because the blockchain itself acts as the intermediary, decentralized exchanges do not entail KYC and AML policies. DEX also means moving towards the core concept of many cryptocurrencies: the decentralized financial ecosystem.
Advantages of DEX
Some of the significant reasons to use a decentralized exchange are:
- You do not have to follow any KYC procedure or wait for the exchange to verify your account. With a DEX, you can get started with cryptocurrency trading almost instantly.
- DEXs do not cause the many problems you find with a decentralized exchange. Because you do not have to transfer your assets to any third party, you are more secure from hacking and theft attempts.
- Decentralized exchanges do not limit the crypto coins and tokens you can trade, unlike centralized exchanges. As long as there is supply and demand, you can use a DEX.
- Using a decentralized exchange instead of a centralized exchange gives you an edge over the control of your assets.
Disadvantages of DEX
Here are some factors to keep track of as well:
- There are times when the fees on DEX are very high. These fees are highly dynamic, and they change according to supply, demand, and network congestion.
- Compared to centralized exchanges, DEX is not that user-friendly. Therefore, even though you need no KYC, getting used to the interface may take some time.
- There are also a few concerns over the average liquidity of decentralized exchanges. Because a DEX does not store any cryptocurrency, there may be times when you cannot buy/sell assets.
It is also worth noting that decentralized exchanges are still in the nascent stage.
Many of these exchanges are limited to a single blockchain network as well.
On the bright side, multi-chain DEXs are being built.
So, it will not be a surprise to see DEXs becoming a core pillar of the crypto ecosystem shortly.