How does a Decentralized Exchange (DEX) work?


A decentralized exchange (DEX for short) allows customers to trade cryptocurrencies. However, unlike conventional cryptocurrency exchanges, they are not centrally managed and are based on blockchain technology. For example, the management of the order book, but also the merging of buy and sell orders, is decentralized.

What is DEX?

A decentralized exchange (DEX) is a cryptocurrency trading venue where interested parties trade directly with each other. Unlike centralized exchanges (CEX), users can trade anonymously on decentralized exchanges and are not dependent on a third-party intermediary.

Thus, a decentralized exchange (or DEX) is a peer-to-peer marketplace where transactions take place directly between cryptocurrency traders. DEXEs fulfill one of the most important opportunities offered by cryptocurrency or blockchain technology: facilitating financial transactions that are not handled by banks, brokers, or other intermediaries. The most popular DEXEs – how Uniswap and Sushi Exchange – use them Ethereum-Blockchain and is part of a growing array of decentralized finance tools that make a wide range of financial services directly accessible through a compatible cryptocurrency wallet.

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How does DEX work?

Unlike centralized exchanges like Coin base DEXEs do not allow exchanges between fiat and cryptocurrencies. Instead, they exclusively trade crypto tokens with other crypto tokens. A centralized exchange (CEX) allows you to trade fiat cryptocurrencies (and vice versa) or crypto-crypto pairs. However, trading on CEX requires bypassing the bank. You can often make more complex trades, such as margin trades or limit orders. However, all these operations are settled by the exchange through the “order book”. It determines the price of a particular cryptocurrency based on current buy and sell orders. The same method used by exchanges like Nasdaq.

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On the other hand, a decentralized exchange is a set of smart contracts (Smart contracts). They algorithmically set the price of different cryptocurrencies against each other and use “liquidity pools”. There, investors deposit cryptocurrency assets in exchange for interest-like rewards. They enable trading and provide liquidity.

While transactions on a centralized exchange are recorded in that exchange’s internal database, DEX transactions are processed directly on the blockchain.

DEXEs are generally based on open source code. This means that, in theory, anyone interested can see exactly how they work. It also means developers can adapt existing code to create new competing projects. Accordingly, following Uniswap’s code there were a number of DEXs with “swap” in their names, such as SushiSwap and Changing pancakes adapt

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What are the pros and cons of DEX?

advantages

Anonymity: No personal information is required to use the most popular DEX. Users can trade without a KYC procedure (Know Your Customer) that you must pass.

Great variety: If you want to find a token that is still in its early stages, DeFi has you covered. DEXEs offer a virtually unlimited range of tokens, from the well-known to the completely unknown.

Usefulness in developing countries: The peer-to-peer lending, fast transactions, and anonymity enabled by DEXs make decentralized exchanges popular, especially in developing countries. Especially when there is no strong banking infrastructure. Because anyone with a smartphone and an internet connection can trade on DEX.

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No central party: Customers can trade with each other on an equal footing. Banks, brokers or other intermediaries become unnecessary. As a result, there are usually lower fees than centralized exchanges. The coins are in your wallet, not on the exchange.

Disadvantages

Customer service: Unlike CEX, there is usually no support or contact person with DEXE. So, if you make a mistake or run into problems, there are limited sources of help (such as the community forum).

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