What are Decentralized Exchanges (DEXs)?

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If you’re just getting into crypto, you might hear about crypto exchanges (online platforms that facilitate the trading of cryptocurrencies) such as Binance, OKX, Coins.ph, or even GCrypto. These are all examples of centralized exchanges (CEXs), crypto exchanges that are managed by a centralized authority. These are where beginners usually flock to because they are similar to other TradFi institutions like stock exchanges. 

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CEXs operate using an order book model which matches buyers and sellers willing to trade an asset at a certain agreed-upon price. 

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They are also more regulated, user-friendly, and have less liquidity (the availability of funds for trading and withdrawal) issues. 

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However, CEXs have some downsides present in TradFi, like relying on the security of centralized firms and trusting the intentions of their central authorities. They also have higher fees and require know-your-customer (KYC) procedures which may not be ideal for those who want privacy. 

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Here’s a cautionary tale: remember the collapse of the major crypto exchange FTX? Last November 2022, FTX began its downfall following rumors that it stole user funds and had an $8 billion hole in its balance sheet. This sparked a bank run, with the majority of users rushing to withdraw their funds (much like the example in the previous module). Soon, FTX had to stop withdrawals, their CEO Sam Bankman-Fried (SBF) resigned and the CEX filed for bankruptcy. A year later, SBF was found guilty of seven counts of graft. Long story short, it ended bankruptcy and legal troubles. Very alarming, indeed! 

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Now, here’s where DeFi swoops in with an alternative – decentralized exchanges (DEXs). These are crypto exchanges that operate without a central authority. Like most of DeFi, trust in intermediaries is replaced by trust in the DEX’s coding. DEX users also retain full control of their assets with no need to surrender their private key. 

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If you’re curious about private keys, check this out: https://www.bitskwela.com/en/digital-signature

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A few DEXs follow the order book model of CEXs, but most use liquidity pools and automated market makers for smoother transactions. A liquidity pool is a collection of funds provided by users to facilitate trading on DEXs. On the other hand, an automated market maker (AMM) is an algorithm that automatically sets the prices of assets based on the available liquidity. These remove the need for an order book by letting users trade directly with the liquidity pool. Some DEXs, such as KTX Finance, also offer both order books with liquidity pool and AMM models. 

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Examples of other DEXs include Uniswap, SushiSwap, and PancakeSwap.

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Let’s now take a closer look at the key features of DEXs:

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• P2P Trading:  DEXs cut out the middlemen, letting users trade directly with each other. This also reduces transaction fees. Win-win! 
  
  
• Smart Contracts: The trust in the DEXs’ code lies in their smart contracts. These are essentially self-executing programs stored on a blockchain. They ensure the terms of an agreement when certain conditions are met, such as offering a certain amount of crypto for trade which leads to the smart contract releasing the appropriate amount of another crypto.  Imagine, a smart contract can be programmed to release 1 ETH when 2,500 USDT is offered. It’s like a digital handshake. Plus smart contracts can be audited to mitigate risks.
  
  
• Privacy:  Unlike CEXes, DEXs usually don’t bother with know-your-customer (KYC) procedures. That means most people can use DEXs with full anonymity!
  
  
• Security: With DEXs, you are in charge of holding your own assets, so no need to worry about the central authorities being negligent with security. Be cautious about potential risks like smart contract hacks or wallet exploits, but choosing a secure platform and understanding wallet security goes a long way.
  
  
• Global Access: DEXs are also accessible anywhere as long as you have an internet connection and have minimal requirements as to whom can use it. This promotes greater financial inclusion and saves you from the hassle of complying with CEX documents. 

• Asset Diversity: There is also a larger and more diverse pool of assets offered in DeFi. Most coins and tokens make their debut on DEXs before hitting the big leagues of CEXes.

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Before we proceed, let’s swiftly recap the pros and cons of using DEXs. 

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Fascinating still, aren’t they! DEXs truly offer a new way to approve traditional asset trading. And now that you understand DEXs beyond the surface level, bet you’re itching to join in the fun. 

Let’s move on and learn how we can actually use DEXs!

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