What Is a Decentralized Exchange (DEX)?
Decentralized exchange (DEX) is a method of trading cryptocurrencies without intermediaries. This type of transaction is called peer-to-peer (also known as P2P) and allows the two parties to trade online securely without the need for a third party to keep everything legit and fair. Even though there are three different types of DEX, they all rely on smart contracts. They are an essential part of decentralized finance (DeFi) and run on the Ethereum blockchain.
Summary of Important Points
- Decentralized exchange is a peer-to-peer form of trading cryptocurrencies online that doesn’t require any form of mediation to be secure.
- There are three different types of DEX, and they all offer different benefits and suffer from different flaws.
- The advantages of DEX are its popularity due to anonymity and the direct approach it takes toward peer-to-peer trading.
- The disadvantages of DEX come from it still being a new concept and the saturated market that has been created about it online.
The 3 Types of Decentralized Exchange
1. On-Chain Order Books
When dealing with on-chain order books, every order is done on the blockchain. This makes it the most transparent, yet the most impractical type, of DEX. It charges you when you are using it, and some believe that it is prone to the issue of front running. This happens when an insider knows about the transaction before it even occurs and abuses this information to place a trade.
2. Off-Chain Order Books
Slightly more centralized than on-chain order books, off-chain order books host their orders away from the blockchain. A dedicated third party is responsible for all the orders, though traders can still enjoy the benefits of non-custodial storage. This type of DEX works much faster than the former, though it is prone to the same issue of front running.
3. Automated Market Makers
The automated market makers work a little bit differently than the previous two types. Namely, they don’t require you to find another trader to exchange currencies. Instead, the trades are done peer-to-contract, and they allow you to exchange with a smart contract. That being said, they are not perfect, as they can cause issues like a potential impermanent loss when unexpected market price changes happen.
Advantages and Disadvantages of Decentralized Exchange
Decentralized exchanges, along with the whole decentralized finance system, are on the rise and, currently, there are over 200 DEX platforms online. While they are not perfect, the trend shows that people seem to prefer them over centralized cryptocurrency exchanges. Here are the pros and cons of DEX, and how it compares to centralized trading.
Advantages
- Anonymity DEX allows you to remain anonymous and keep your personal information for yourself when trading. All you need is a crypto wallet, and you are good to go.
- Growing popularity DEX is becoming more and more popular every day. With its continuous integration of fiat currency pairings, it is very possible that it will become the most popular form of trading one day.
- Peer-to-peer The most important advantage of DEX is that it allows you to trade directly with another user, without any mediation of a third party, making it on your side instead of banks always looking to turn a profit.
Disadvantages
- Trustworthiness Even though it is on the rise, DEX is a relatively new concept, and it is going to take some time to earn the trust of the general public.
- Visibility Because DEX is new and there are over 200 platforms online for it, this means that most of them don’t get the needed visibility to succeed.
- Scammers It is hard to verify the legitimacy of DEX platforms, and there were numerous reports of investors being scammed when they were first released.
- Liquidity With a saturated market such as DEX at the moment, it might become difficult to find traders online and exchange currencies.