Decentralized Exchanges

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Overview

An exchange is basically a platform that gives its users the chance to trade a particular asset for another. In cryptocurrency, exchanges are platforms to exchange different crypto currencies, like Steem for USDT. Based on how they operate, most of the crypto exchanges are in the form of websites and web applications, and they are broadly classified into two main forms: centralized exchanges (like Binance, Houbi, and Gate.io) and decentralized applications. Most of them, like banks, adhere to government regulations, so users are required to verify their accounts with their identities. On the other hand, decentralized exchanges, on the other hand, bring decentralization when it comes to trading crypto currencies. This presentation is about decentralized exchanges and their benefits and drawbacks.

What then are Decentralized exchanges?

Decentralized exchanges, as the name implies, are platforms to exchange assets (mainly crypto) without the involvement of any third party in trading one asset for another. That is, the custody of cryptocurrencies in decentralized exchanges is in the hands of the users who hold the cryptocurrencies in the exchange. PancakeSwap, UniSwap, SushiSwap, 1Inch Exchange, HoneySwap and many more are among the 121 DEXs listed by Coinmarketcap. Trades on decentralized exchanges are managed by smart contracts. Smart contracts are computer programs that are used to facilitate swaps and liquidity pools of assets for users in decentralized exchanges. Users in decentralized exchanges are not required to go through any registration process before they can operate; hence, there is no need for any verification. The only requirement is to connect your wallet with the exchange. After that, you can start trading instantly. Decentralized exchanges employ blockchain technology to foster high security and transparancy in trading cryptocurrencies. The exchanges do not handle the assets as they are being handled and controlled by users in a peer-to-peer network using the blockchain technology. Users only need to handle their wallet keys securely and use them to verify transactions in their wallets.

Top DEXs in CoinmarketCap by Trading Volume

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Swap DEXs

The majority of the current decentralized exchanges we have today use a particular model called the Authomatatic Market Maker (AMM) and the Proactive Market Model (PMM). We call this DEX swap DEXs. When using the AMM model, the transactions in the exchange are calculated with the available tokens in the smart contracts that facilitate the transactions. The smart contracts will then execute the transaction based on the current price of the token. The proportion will determine the token's price. A major drawback of the swap DEXs is that, there is higher slippage in large transcations. Swap DEXs usually charge fixed swap fees, and that is where the exchange generates income for the platform's development. Examples of swap DEXs include: PancakeSwap, SushiSwap, and JustSwap.

Orderbook DEXs

Another model that has now been employed by some of the DEXs is the orderbook model. They are being used by orderbook DEXs. We have buy (bid) and sell (ask) orders in the orderbook, just like in traditional exchanges, such as the Binance order book. A sell order is placed. A matched buy order will cancel it and vice versa. In most of the DEXs that use the order book model, the user's assets are handled off-chain, but only the information about the assets will be on-chain to facilitate quicker trades with the order book. The correlation between the bid and ask prices usually determines the price of the asset. A major drawback here is that there are usually higher fees due to trade collisions. Examples of DExs that use the orderbook model include: DYDX, Serum, IDEX, EtherDelta, and ParaDEX.

The Advantages of Using DEXs

Transparency A major benefit of using a decentralized exchange is transparency. The exchange doesn't keep the assets; hence, they have no access to them; but rather, users hold their assets in their wallets with their private keys. The security is in the hands of the users. If hackers are able to access the exchange, they can't interfere with users' funds.

Confidentiality: DEXs have high confidentiality because users do not need to pass any verification level before they can access certain features; they simply connect their wallet to the exchange without any identity verification with any third party entity.

No Regulation DEXs do not work under any centralized entity, so no regulatory body can close a DEX down. They are managed by the public ledger, which is an interconnection of independent nodes globally.

DEX drawbacks

NO Fiat transactions Users are not given the chance to conduct transactions with fiat currencies. When they want to convert the crypto assets to fiat, they have to send them across CEXs.

Complex for Beginners The interfaces of the various DEXs are not user friendly, hence, beginners usually find it very difficult to operate them.

Lack of Public awareness When you compare the centralized exchanges to even the popular DEXs, you'll realize that they lack the public attention of users.

Conclusion

When it comes to public awareness, most of the DEXs are still in their infant stage. A lot needs to be done so that they will become mainstream. The use of DExs should become mainstream as they are in line with the core principles of cryptocurrencies, which is decentralization. We are used to working with the centralized exchanges. That is why it is required to learn more about the DEXs before using them, as most of them require some technical knowledge due to how they are built. Thank you for your time.