What Is a DEX and How Decentralized Crypto Exchanges Work?

Decentralized Finance or DeFi can seem a perplexing notion for those far from the world of Web3. Is it purely related to crypto or non-fungible tokens? Is it a sort of financial technology?

Decentralized Finance actually uses cryptocurrencies to function but spans a large number of directions and excludes classic financial establishments and governments as intermediaries.

DeFi covers a range of day-to-day financial services, such as insurance, asset management, payments, yield farming, and more. However, the most popular activities on DeFi are decentralized exchange (DEX) and lending or borrowing.

What is a DEX?

Decentralized exchanges are not governed by a central authority—national central banks, FCAs, SEC, or any financial auditors—and specialize in the trading of cryptocurrency, stablecoins, NFTs, synthetic assets, and others.

Put simply, through DEX, traders can directly communicate with each other and have more dominance over their belongings and privacy. The most prominent examples of DEXs are Uniswap, SushiSwap, and Curve.

How do decentralized exchanges work?

To start trading on a DEX, users simply add their crypto wallets to the preferred platform. The wallet then works with the DEX’s smart contracts, which administer all parts of trading—executing trades, matching orders, and transferring assets.

Unlike traditional exchanges, which use a central order book, DEXs often lean on automated market makers (AMMs) or other decentralized systems to set prices and command trades. AMMs use “liquidity pools,” where users deposit tokens. These pools help complete trades based on preset conditions.

Because DEXs are decentralized, there’s no need to create an account or go through sesquipedal verification procedures. Users can swap assets directly and stay in charge of their decisions.

Why Moving to DEXs from Other Exchanges

Since DEXs are built on blockchain, there’s no middleman running the show, which means more transparency and less censorship for users. Traders keep full dominance over their capital and keys, so there’s less chance of the funds being frozen or accessed without a say-so.

Next, DEXs employ smart contracts to automatically execute operations—no need to trust anyone else. Plus, they’re open to anyone worldwide, so it becomes possible to trade from any jurisdiction.

For example, if User A wants to swap 1 ETH for 100 DAI, the smart contract will hold onto User A’s ETH and look for DAI in the liquidity pool. When it finds a match, it locks both users’ assets, checks that everything’s good to go, and then completes the trade.

In terms of fees, DEXs are generally cheaper than traditional exchanges and also offer a much larger selection of tokens, some of which you never find on traditional platforms.

Decentralized exchanges, or DEXs, are finally a hotspot for new crypto inventions. They let developers whip up new decentralized applications (dApps) and services. Everything built on these platforms gets recorded on public blockchains, so it’s all glasslike and open for everyone to see.

Things to Know Before Using DEXs

Like trading in general, decentralized trading requires certain knowledge. They often have a steeper learning curve and users are obliged to get familiar with new matters (liquidity and slippage, token standards, wallet management) and different dashboards, screens, and graphs.

Where there is potentially more money, there are also more risks. And despite the fact that positive dynamics are observed, DEXs still operate in a regulatory gray area, which means there’s not much legal support or protection in case of fraud, disputes, or price manipulation.

Smart contracts, which DEXs widely employ to execute trades, can also bear the risks. Although they are normally tested for safety flaws, vulnerabilities can still exist and pop up from time to time causing financial lesions.

Asset liquidity is also an important factor that applies broadly across the crypto space. Although the situation is improving, DEXs may still not have the same liquidity as centralized exchanges, which can lead to thinner order books and higher costs for larger trades.

Lastly, remember that transactions on DEXs are usually irreversible when submitted on the blockchain. If a user accidentally sends money to the wrong address, it can be very difficult, if not impossible, to get it back.

Takeaway: Give DEXs a Try

Decentralized exchanges, or DEXs, are a gainful alternative to classic exchanges because they give traders better control over funds and let them trade directly with others, so there are no censorship, bans, and regulating authorities.

In a couple of years, DEXs are likely to improve in terms of support and inner processes and fix their current weaknesses, making them an appealing choice for traders looking for promising opportunities.

If you need help with decentralized exchanges, SCAND is here for you. We’ve got a ton of crypto services to offer, such as building exchanges, developing trading bots, creating wallets, and hooking up with other services. Just reach out to chat about what you need.