According to market experts, the growth and survival of cryptocurrency largely depend on decentralization. The good news, in this case, is that the decentralized exchanges or DEXs have become very famous, and the crypto space sees this as a chance to save the motive of traditional blockchain.
Every decentralized exchange platform has the ability to revive and thrive in the crypto space. Moreover, each latest DEX platform arrives with its own set of features. There are several ways by which you can use DEX and make money out of it.
What Are Decentralized Exchanges?
Decentralized exchanges depend on smart contracts to enable traders to implement orders without any intermediary. On the contrary, centralized exchanges are managed by a centralized organization like a bank that is otherwise associated with financial services that are looking to earn profit.
These centralized exchanges account for a huge majority of trading volume in the digital currency space as they are regulated organizations that custody the funds of the users and provide easy to use platforms for beginners.
In contrast to that, decentralized exchanges enable users to trade directly from their wallets by interacting with the smart contracts behind the trading channels. Traders protect their funds and are responsible for losing them if they commit any mistake like losing their private keys or even sending funds to the wrong address.
The deposited assets of funds of the customers are issued an “I owe you” through exchange portals, which can be traded freely on the network. An IOU is primarily a token that is based on the blockchain. The most famous DEX is formed on the Ethereum blockchain.
How Does DEX Work?
As DEX is created on top of blockchain networks that support smart contracts where users keep custody of their funds, every trader will have to pay a transaction fee along with the trading fee. Generally, traders communicate with smart contracts on the blockchain to use DEX.
There are three primary types of DEX: Automated Market Maker, DEX Aggregator, and Order Book DEX. All of them enable users to trade directly with each other via their smart contract. Now let us have a look at these types in detail.
Automated market makers (AMMs)
An AMM (automated market maker) system that depends on smart contracts was built to solve the liquidity issue. The creation of these exchanges partly arrived from inspiration evolving from Ethereum co-founder Vitalik Buterin’s paper on DEX, illustrating how to implement trades on the blockchain using contracts holding tokens.
These AMMs depend on blockchain-based services that offer information from exchanges and also other platforms to set the value of traded assets known as blockchain oracles. Instead of matching purchase orders and sell orders, the smart contracts of these DEXs use pre-funded pools of assets called liquidity pools.
Order Book DEXs
Order books assemble records of all open orders to purchase and sell assets for specific asset pairs. Purchase orders indicate that a trader is willing to purchase or bid for an asset at a specific value, while sell orders signify that a trader is ready to sell or ask a specific price for the asset under consideration. The spread between these prices evaluates the depth of the order book and the market value on the exchange.
DEX aggregators use various varied mechanisms and protocols to solve issues related to liquidity. These platforms mainly aggregate liquidity from several DEXs to decrease slippage on big orders, optimize swap fees, and token values and provide traders the best value possible in the shortest possible time.
Protecting users from the pricing impact and decreasing the likelihood of failed transactions are two other prominent aims of DEX aggregators. Some DEX aggregators also use liquidity from centralized channels to offer users with a better experience, all while staying non-custodial by taking advantage of an integration with specific centralized exchanges.
Advantages Of Decentralized Exchanges
Trading on decentralized exchanges can be costly, mainly if network transaction fees are big when the trades are implemented. Nevertheless, there are several benefits of using DEX platforms.
Centralized exchanges have to vet tokens individually and assure they comply with all local regulations before listing them. Decentralized exchanges can have any token that is minted on the blockchain they are created upon, implying that the latest projects will likely list on these exchanges before being available on any centralized counterparts.
While this can imply traders can get in as early as possible on any projects, it also narrates that all types of scams are listed on DEXs. A common scam is known as a “rug pull,” which is a typical exit scam. Rug pulls happen when the team behind any specific project dumps the tokens used to offer liquidity on these exchanges’ pools when their values increase, making it impossible for other trades to sell.
When users exchange one digital currency for another, their anonymity is safeguarded on DEXs. In contrast to centralized exchanges, users do not require to go through any standard identification process called KYC (Know Your Customer). KYC processes related to collecting personal information of a trader, that include their complete legal name and a picture of their government-issued identification document. As an outcome, DEXs attract a big number of people who do not wish to be identified.
Reduced Security Risks
Experienced digital currency users who custody their funds are at a decreased risk of being hacked using decentralized exchanges, as these platforms do not control their funds. Instead, traders guard all their funds and only interact with the exchange when they want to do so. If the platform is being hacked, only liquidity providers may be at risk.
Reduced Counterparty Risk
Counterparty risk occurs when the other party associated with a transaction does not comply with its part of the deal and defaults on its contractual duty. Because decentralized exchanges function without intermediaries and are dependent on smart contracts, this risk is discarded.
To assure no other risks occur when using a decentralized exchange, users can quickly do a web search to find out whether the smart contracts of the exchange have been audited and can make decisions based on other traders’ experience.
Disadvantages Of Decentralized Exchanges
Despite the advantages that have been stated above, there are several drawbacks of DEX that include a lack of technical knowledge required to interact with these exchanges, the number of smart contract vulnerabilities, and also unvetted token listings.
Specific Knowledge Is Required
DEXs are accessible using crypto wallets that can communicate with smart contracts. Not only do users have to know how to avail these wallets, but they also have to understand security-related ideas related to keeping their funds safe.
These wallets have to be funded with the right tokens for each network. Without the native token of a network, other funds may get stuck, as the trader cannot pay the fee needed to move them. Specific knowledge is needed to both select a wallet and fund it with the right tokens.
Smart Contract Vulnerabilities
Smart contracts on blockchains such as Ethereum are publicly accessible and anyone can review their code. Along with that, smart contracts of large decentralized exchanges are audited by reputable firms that help secure each code.
To err is human. Hence, exploitable bugs can still ignore past audits and other code reviews. Auditors may even be unable to see potential latest exploits that can cost liquidity providers their tokens.
Unvetted Token Listings
Anyone can list the latest token on a DEX and offer liquidity by pairing it with other cryptos. This can leave the investors susceptible to frauds like rug pulls that make them think that they are purchasing a different token.
Some decentralized crypto exchanges face these risks by asking users to authenticate the smart contract of the tokens they are searching to purchase. While this solution operates for experienced users, it comes back to specific knowledge issues for others.
Before purchasing, traders can try to get as much data as possible about a token by knowing its white paper, joining its sector on social media, and searching for potential audits on the project. This type of awareness helps avoid common frauds where malicious actors take advantage of unsuspecting users.
3 Best Decentralized Exchanges 2022
The decentralized exchanges make more sense as there is no central governed authority. In this year, DEXs are at the forefront in the crypto area and even fighting with big CEX platforms. Unlike the last bull run, the crypto trading environment alters and also evolves. With that, let us have a look at a list of decentralized exchanges that are presently operating.
When it is about the DEX market, Uniswap has had the ideal record. Of course, the DeFi king has undergone endless obstacles. But the ample liquidity and simplicity of Uniswap always make up for it. As the best decentralized exchange platform, Uniswap functions through its dedicated model.
The ownership of the channel is regulated via a governance model that enables users to showcase voting rights within their native Uniswap governance. The technicalities of trading with Uniswap are also not as complex as other decentralized exchanges. Uniswap charges the trading of 0.3 percent on every token swap. Depending on the contribution, yield farmers finally get a part of the fees.
On Uniswap, liquidity pools have a token ratio of 1:1 that all users must abide by. As of now, Uniswap hosts over $3.72 billion in respect to collateralized assets. Since the rollout of this DEX is 2018, it has been an era-defining and transformative decentralized exchange platform.
Remember that Uniswap enables users to swap ERC-20 tokens via the Ethereum blockchain and without any order book. Fundamentally, Uniswap revolves around clever contract use and will allow users to exchange or trade crypto without any third-party intermediaries. The ultimate aim of Uniswap is to enable its users to tackle exchange governance on their own.
If you wish to try something new and varied, changing to a PancakeSwap would be wise. As the best DEX platform, Pancake Swap operates around Binance Smart Chain. On the base, it is a Uniswap clone, but it has a great reputation for dApps.
The fact of the subject is that Pancake Swap took its time to kick off in the developing DeFi market. After the latest Ethereum fees controversy, the project increased to its latest heights in 2021. As of this year, Pancake Swap is the third-best DEX platform in trading volume.
What is interesting is that anonymous developers function as PancakeSwap. However, users get the full freedom to control any project within decentralized rules such as voting via CAKE token governance. Pancake charges a fee of 0.2 percent on its token swaps. Liquidity providers receive 0.17 percent, while the treasury burns 0.03 percent. Along with that, yield farmers receive LP tokens and fees in the form of rewards.
Pancake Swap has become best for swapping BEP-20 tokens via BSC (Binance Smart Chain). Technically, PancakeSwap uses AMM (automated market maker) model enabling users to trade tokens against a prominent liquidity pool.
Typically, these pools have funds from varied users. Mostly, users deposit these funds into an independent pool and receive LP tokens as rewards. Users can use these tokens to get part of the real trading fees.
If you are not on board with PancakeSwap or Uniswap, then 1inch provides a more convenient and collective trading experience. Unlike traditional DEXs, the hallmark dimension of the 1inch Network is that it functions as a DEX aggregator.
Even though the DEX project is not as famous as Pancake Swap or Uniswap, it prevails to gain momentum in the decentralized exchanges area. Another highlight of this exchange is that it assembles liquidity from many independent trading platforms and liquidity pools.
The focus of a 1inch Network is to receive the ideal possible rate and provide effective trading to its users. It is the primary reason 1Inch uses capital from most DeFi sectors. This strategy enables 1inch Network to lower its fee, enabling it possible for traders to spend less on the gas fees.
In the latest developments, 1inch has had integration with Nexus Mutual. It implies now users can receive insurance coverage for their DeFi-based actions. Not to mention, users receive dedicated access to the governance model and can also take advantage of attractive yield farming tactics.
In a short period of time, decentralized exchange platforms have had a meaningful impact on the digital currency space. In retrospect, DEX platforms like Pancake Swap and Uniswap have become the most popular platforms that mix varied blockchain protocols. After all, DEXs divide ownership right back to its own community. The trading process of DEX operates completely via intelligent contracts.
Another hallmark dimension of decentralized exchanges is that they are completely non-custodial, boosting a secure and safe space for crypto investors. Decentral exchange platforms deserve to remain in the spotlight despite constant obstacles and absurd restrictions. It would be fair to state that DEXs are perfect.
Frequently Asked Questions On Decentralized Exchange
A common decentralized exchange example is any crypto trading platform like Binance, or Coinbase, where buyers can directly buy or sell digital currencies without the involvement of any intermediary.
Because users are not required to transfer their assets to the exchange, DEX reduces the risk of theft and hacking from exchanges. There are some indications that the decentralized exchanges have been going through low trading volumes and market liquidity.
Decentralized exchanges take a varied approach to buy and sell digital assets: They function without a third party organization for clearing the transactions, relying instead on self-executing smart contracts to conduct trading. In the absence of any third party, DEXs grab a non-custodial framework.
The benefits of decentralized exchange include vast variety, reduced hacking, anonymity, and utility in the developing nations. The Binance DEX is said to be the best decentralized exchange 2021.