The introduction of Decentralized exchanges helps cryptocurrency holders take complete control of their assets. Today, we will go deeper into what a Decentralized exchange is, why use Decentralized exchange, Decentralized exchange with lowest fees, and more!
What are Decentralized Exchanges?
A Decentralized crypto exchange is a peer-to-peer marketplace where users can trade cryptocurrencies in a non-custodial manner without the need for an intermediary to facilitate the transfer and custody of funds.
DEXs use smart contracts, which self-execute under certain conditions and add each transaction to the blockchain. These secure, trustless transactions are leading the way for new financial products and are a growing sector of the digital asset market.
Decentralized exchanges provide complete transparency into the movement of funds and the mechanisms facilitating trades, in contrast to traditional financial transactions, which are opaque and conducted through intermediaries who provide very little insight into their actions.
How Decentralized Exchanges work
The idea behind many Decentralized exchanges is to have permissionless accessible, end-to-end on-chain infrastructure with no single points of failure and decentralized ownership across a community of distributed stakeholders.
Decentralized exchanges are highly deterministic thanks to the use of smart contracts and blockchain technology. Decentralized exchanges (DEXs) carry out trades using smart contracts and on-chain transactions, as opposed to Centralized exchanges (CEXs), like Blockchain.com or Tidex, where the platform facilitates trading using the Order Book model.
If you’d like a more detailed explanation of Centralized exchanges, read this post covering How Centralized Exchange works.
DEXs also gives users the option to trade while maintaining full custody of their money in self-hosted wallets. Decentralized exchanges also conduct trades with associated trading costs. These charges are collected by the underlying protocol, its liquidity providers, token holders, or a combination of these parties in accordance with the protocol’s design.
There are various DEX designs, and they all have advantages and disadvantages in terms of feature sets, scalability, and decentralization. Order books and Automated Market Maker (AMM) decentralized exchanges are the two most popular types.
Order Book Decentralized Exchange
Order books were used in the early stages of decentralized exchanges to store transactions. Similar to centralized exchanges, it monitors all open buy and sell orders for a specific asset; the depth of the order book is determined by the difference between this price and the open market price.
Decentralized exchanges with order books keep data on-chain during transactions while your money is kept off-chain in your wallet. In order to complete a transaction, a willing buyer must wait for their order to be matched with the order of a seller.
Order book exchanges are now more practical and draw a significant amount of trading activity thanks to scalability innovations. Some popular Order book Decentralized exchange examples include Serum, Loopring DEX, and dYdX.
Automated Market Makers (AMMs) Decentralized Exchange
AMMs are the most popular and cutting-edge technology used in decentralized exchanges because they allow for instant liquidity, democratized access to liquidity provision, and frequently permissionless market creation for any token.
AMM establishes the price between token pairs, unlike order book Decentralized exchanges. Users of AMM can also exchange their tokens against a liquidity pool, with the price set by an algorithm based on the percentage of tokens in the pool.
In the case of an AMM, a smart contract controls the exchange rate. Liquidity can be instantly accessed by users, and liquidity providers can profit passively from trading commissions.
AMMs have seen a huge increase in the number of new token launches thanks to the combination of instant liquidity and democratized access to liquidity provision. This has also allowed for the development of new designs that concentrate on specific use cases, such as stablecoin swaps. Some popular AMM Decentralized exchange examples include PancakeSwap, Sushiswap, and Uniswap.
If you’d like a more detailed explanation of AMMs, read this post covering Automated Market Maker for DeFi.
Why use Decentralized Exchange
Decentralized cryptocurrency exchanges already have advantages over centralized ones in terms of investor privacy, transactional trust, diversity and custody of digital assets, and trading fees.
DEXs are non-custodial, which means traders don’t need to relinquish control of private keys to transact. Instead, externally held wallets interact with DEXs, and trades self-execute through smart contracts. By controlling your private keys, centralized exchanges, in contrast, act as the custodian of your money. This requires you to relinquish control of your private keys, but centralized exchanges offer trust and security.
The vast majority of frequently used DEXs don’t request the entry of any personal data. Decentralized exchange users don’t have to reveal their private keys because their wallets are kept externally and the DEX is not responsible for the funds. Decentralized exchanges without KYC and AML procedures help increase anonymity. While this may be advantageous in regards to convenience, it can be unsafe.
Decentralized exchanges are powered by self-executing smart contracts. DEXs use the same “gas” fee structure as the Ethereum blockchain they are built on in the absence of an intermediary. For exchanges like Uniswap, DEXs charge a low fee of around 0.3%. Although these fees vary according to network utilization, they remain significantly lower than the costs incurred by centralized alternatives.
Every transaction on a Centralized exchange is monitored and recorded by a central authority, the exchange itself. Decentralized exchanges execute trades and record them on the blockchain using smart contracts, enabling trustless transactions.
Decentralized Exchange with Lowest Fees
Decentralized exchanges have been known to charge lower fees when compared to centralized exchanges that charge a ton of fees like maker, taker, trading, and even maintenance fees amongst others. Interacting with a Decentralized exchange can exempt you from all these fees.
Trading fees on Decentralized exchanges are based on swapping and are intended for liquidity providers. The table below displays a list of Decentralized exchanges and their trading fees.
Is Decentralized Exchange safe?
Decentralized exchanges have seen high levels of decentralization. Here Investors have the privilege of maintaining direct custody of their private keys and showing direct ownership of crypto assets, which is what makes them highly distinguishable from Centralized exchanges.
Although compared to Centralized exchanges, Decentralized exchanges are not completely immune to all threats, they are generally more secure and reliable, so there is almost no risk of getting hacked.
There have been more hacks on Centralized exchanges than there have been on Decentralized exchanges, forcing them to put a great deal of effort into blocking these activities or dealing with the fallout. As a result, some of them are now offering their customers more reliable, decentralized wallets so users can maintain custody of their funds.
Bottom line: Are Decentralized Exchanges the Future?
Although Centralized exchanges continue to dominate the cryptocurrency market and serve the needs of everyday crypto traders and investors, decentralized exchanges offer an intriguing alternative.
DEXs have grown in popularity in recent years due to the instant liquidity they can provide for newly launched tokens, the seamless onboarding experience they provide, and the democratized access to trading and liquidity provision they provide.
It remains to be seen whether the majority of trading activity will migrate to decentralized exchanges, as well as whether current DEX designs will support long-term growth and institutional adoption.
However, these platforms are still in their early stages, and further user experience refinement, infrastructure development, improved scaling mechanisms, and increased connections to centralized crypto and legacy financial institutions will be required to ensure future adoption.