What is a decentralized exchange (DEX)?

Decentralized Exchanges (DEXs) are a platform that competes with traditional crypto exchanges. Their particularity is that they operate on the blockchain, which means that they allow direct exchanges between users. This, therefore, does not require an intermediary, which is the case with Coinmerce, for example. Of course, this sounds very advantageous, but it can also come with disadvantages. We will explain to you in this article what a decentralized exchange (DEX) is.

Decentralized exchange (DEX)?

Decentralized exchanges are a certain type of dApp (decentralized application) that allow direct transactions of cryptocurrencies between users. This can all be done in a secure manner and without intermediaries. They are the decentralized version of traditional exchanges and compete directly with the largest players within this market. Think of exchanges like Coinmerce, Binance, ByBit, Kraken, etc.

Are DEXs completely decentralized?

DEXs are more decentralized than traditional exchanges. They always run on a blockchain, and in that respect, they are completely decentralized. Still, this differs a lot per exchange. The way a DEX handles certain matters also determines how decentralized the exchange is.

Well-known DEXs are Uniswap, Sushiswap, 1inch and PancakeSwap. Incidentally, UNI-token (the token of Uniswap) and 1INCH (token of 1inch) are also for sale at Coinmerce.

How does a traditional exchange work?

For a traditional exchange to work, there are several trusted intermediaries involved. So there are always several people needed in advance to make a traditional exchange work.

First, the user must be able to transfer money to the exchange before it can be exchanged. This requires cooperation from banks, payment systems and governments to authorize and secure the transaction. Generally, governments require exchanges to implement KYC procedures to collect and record information about their customers. For example, governments want to address anonymity, tax evasion or money laundering.

Next, the exchange offers a place to exchange fiat money or crypto coins for other cryptocurrencies. For example, if you want to buy ADA with BTC, there will have to be someone willing to exchange BTC for ADA. Thus, liquidity must always be required before a transaction can be executed.

How does a DEX work?

Decentralized exchanges are fundamentally different in the way they work, as users exchange money directly with each other. There is no transfer of money or cryptocurrencies to or from the DEX: the DEX directly connects two users who wish to exchange money.

Thus, the exchange of currencies occurs directly from the users' crypto wallets.

As on any exchange, DEX works with a 'maker' and 'taker'. The maker is the one who 'makes an offer on the exchange, to buy or sell something. For example, the creator might make an offer to sell 1 BTC for 39 ETH. The taker is then the one who will fulfil the offer.

Smart contracts

The exchanges between cryptocurrencies in DEXs are governed by smart contracts, to ensure that the coins arrive in the right wallets. Each DEX has its own smart contract. This is also why you have different decentralized exchanges that all work in a slightly different way.

Disadvantages of DEXs

There are many advantages to a DEX. For example, no intermediaries are used, so you are less dependent on others. On a DEX you will also encounter a cryptocurrency that is not yet for sale anywhere else. In that case, you can buy the cryptocurrency for a much lower price. Still, there are plenty of disadvantages to using a DEX.

The performance problem of blockchains

On blockchains with smart contracts (such as Ethereum, on which 9 of the 10 largest DEXs are located), it is difficult to perform hundreds or thousands of transactions per second. This creates several problems for DEXs.

For example, on a traditional exchange, someone can constantly adjust the prices of their order. And they should because the market is constantly changing. However, blockchains are limiting in this area because, on the one hand, the speed of execution cannot be guaranteed. On the other hand, each transaction involves a lot more cost. As a result, users could lose a lot of money when something goes wrong.

Difficult to use for the average crypto trader

A DEX is not at all that easy to use. To use a DEX, you will first have to open a special wallet. Think for example of TrustWallet or MetaMask. Next, you need to send crypto coins from the central crypto exchange to the DEX. When you have received them on this, you can link the wallet to a DEX like Uniswap or PancakeSwap. On the DEX you can buy the cryptocurrency or token of your choice, after which it is sent directly to your wallet. In the wallet, the cryptocurrency is visible once you enter the token address.

For the novice and average crypto trader, it is quite difficult to execute a transaction on a DEX. Even when you do have experience with it, it still takes quite some time. Because you have to transfer money several times to different addresses, it takes some time before you have actually purchased a coin. This is why most crypto traders still use central exchanges. These are a lot easier and faster to use than DEXs.

Central DNS management

The Internet is constantly changing, and new technologies are emerging all the time. Still, the Internet currently operates in a centralized manner. When you go to Uniswap.org, you should be aware that this domain name can just be controlled by authorities. This is because DNS management is still centralized.

The independence of DEX

The developers of a DEX have control over what happens on the platform. It is important to see how the project is managed and who decides on its future. Uniswap, for example, is an open-source project, and the future of the project will now be controlled by the UNI token holders. However, this is not the case for all DEXs (Binance DEX, for example, is not open source).

Conclusion

Decentralized exchanges are the next step in the evolution of exchanges. While these pertain to the cryptocurrency world, some decentralized exchanges for other assets are also beginning to emerge (think iExec, for example).

Like everywhere else, smart contracts remove the need for an intermediary, which many see as a positive progression. However, DEXs are still in their infancy at the moment, making it very difficult to make use of them. Therefore, if you want to buy crypto coins without too much difficulty, it is still much better to choose a centralized exchange like Coinmerce.