Decentralized Exchange (DEX) is defined as a peer-to-peer marketplace that creates a connection between users who carry out buying and selling transactions of cryptocurrencies. It is considered as a decentralized exchange and serves as a platform.
A special key is required to execute transactions on the decentralized exchange. Smart contracts that record every transaction on the blockchain are used on DEXs.
The DEX platform is managed without the need for a third-party private company that knows about every transaction, instead of being managed by a broker. The asset traded on the DEX platform never faces the broker. The main purpose of the platform is to facilitate buying and selling transactions.
How Does Decentralized Exchange Work?
Decentralized Exchange is built on blockchain networks that use smart contracts and hold users' funds. The DEX platform conducts transactions around assets on blockchain networks. Traders interact with smart contracts on the blockchain to use DEXs.
Decentralized exchange (DEX) is divided into three main types:
- Automated Market Makers (AMM)
- Order book DEXs
- DEX aggregators
Automated Market Makers
Automated market makers are a system based on smart contracts to solve the liquidity problem. AMMs rely on blockchain-based services that provide information from platforms to determine the prices of assets traded. They use smart contracts and liquidity pools.
Pools are financed by other users who earn the fees requested for trading pairs on the contract. Liquidity providers must invest an equivalent value of each asset in the trading pairs to earn interest from cryptocurrencies. The use of liquidity pools is based on executing orders and earning interest based on trust.
Order Book DEXs
Order books gather records of all open orders for trading assets for trading pairs. Buy orders show that the trader is ready to buy an asset at a specific price. Sell orders show that the trader is ready to sell the asset at a specific price. The difference in prices determines the market price on the platforms.
Order book DEXs are divided into two types:
- On-chain order books
- Off-chain order books
DEX Aggregators
DEX aggregators use several different mechanisms to solve liquidity problems. They collect liquidity from the DEX to make transaction fees and cryptocurrency prices as affordable as possible and offer the best possible price to traders in the shortest time. The main goal of DEX aggregators is to protect users from pricing effects and reduce the likelihood of failed transactions.
How to Use Decentralized Exchanges?
Using a decentralized exchange does not require any registration process. To use a decentralized exchange, traders only need to have a wallet that is compatible with the smart contracts on the platform network. Financial services offered by DEXs can be accessed through any device with an internet connection.
To use DEXs, the user must first decide which network they want to use. Then, a wallet compatible with the chosen network must be obtained and funded with the local cryptocurrency.
What Are the Advantages Decentralized Exchange Provide?
Decentralized Exchange (DEX) offers advantages such as storing assets, building transaction confidence, low transaction fees, and protecting user privacy:
Anonymity
DEXs protect the information of users who perform cryptocurrency transactions and ensure their anonymity. Unlike centralized exchanges, users do not need to go through KYC processes.
Availability of cryptocurrencies
DEXs can include any cryptocurrency created on the blockchain on which it is built. This means that new projects can be listed on platforms without centralized intervention.
Security
Users reduce the risk of being attacked by using DEXs. With DEXs, users protect their assets and only interact with platforms when they want to.
What Are the Disadvantages of Decentralized Exchange?
- Decentralized exchange works with smart contracts on the blockchain network. Therefore, the decentralized exchange needs to work depending on the limit of the network structure.
- Decentralized exchange relies on wallets, so it requires user experience. Therefore, it is considered a disadvantage for users with insufficient experience.
