Cryptocurrency is becoming mainstram, especially when Bitcoin rose in value in the early quarter of 2020s. Now, many people are interested in learning more about how to trade and invest in these digital assets because of the high profits they can reap.
To maximise their assets and ensure security, users flock to centralised exchanges because of the ease of use but there’s an alternative where you’re free of a financial middleman whenever you create crypto transactions. That’s where decentralised exchanges come to play.
Learn more about the ins and outs of decentralised exchanges as you browse through the article.
Decentralised exchanges explained
When using a decentralised exchange or DEX, there’s no need for users to interact with brokers or any central authority. These platforms are basically peer-to-peer marketplaces that help users carry out transactions directly, meaning that the responsibility for managing the crypto funds are not transferred to intermediaries. Instead, these are carried out by algorithms that are run by smart contracts.
DEXs are non-custodial. This allows users to also have direct access and ownership of their coins and tokens as well as the private keys to their wallets.
How decentralised exchanges work
In essence, DEXs are algorithms made up of smart contracts. This is what the users interact with to make transactions on the blockchain.
For the platform to work, DEXs relies on smart contracts to allow traders in executing their orders without the help of any intermediaries, as what a centralised one would have had. Since it’s built on top of a blockchain, this kind of algorithm that makes use of smart contracts makes it easier for users to interact with one another directly.
So how does a DEX work alongside a smart contract? A smart contract is a formal agreement that’s written in code between two interacting parties. This is composed of the contract creator and the receiver.
When both parties agree with the conditions of the contract then it’ll self execute and record the data on the blockchain.
Centralised vs decentralised exchanges
Although many sophisticated traders make use of decentralised exchanges, many people are more comfortable using centralised and custodial platforms like Coinbase, Binance and other regulated intermediaries.
Centralised exchanges are what makes up the vast majority of trading in the crypto market since it’s easier to use compared to decentralised platforms. That’s because it acts as a bank with a central authority to enact the transactions you wish to do for your crypto assets.
You can also exchange different currencies using a centralised exchange. This isn’t possible on a DEX platform since it’s built on top of a blockchain. Only coins and tokens accepted on thE ledger will be able to be exchanged unless you use a blockchain bridge.
Moreover, centralised exchanges provide security and surveillance services to keep the assets safe. However, this can be restricting since the user cannot deliver their transactions independently.
On the other hand, decentralised exchanges have no central authority as previously mentioned in this article. This means that all the responsibility in trading and keeping the assets safe is in the hands of the users.
Types of decentralised crypto exchanges
To understand DEXs and how they function even further, you must learn the different types of this platform you can encounter. There are three main types of decentralised exchanges namely:
Automated Market Makers (AMMs)
When talking about decentralised exchanges, you’ll come across the term Automated Market Makers or AMMs. These systems use smart contracts to address liquidity problems in a blockchain. Instead of matching buy orders and sell orders on the ledger, an AMM-based exchange leverages liquidity pools.
How does this work? It requires users to provide funding for the liquidity pools and are then rewarded with transaction fees on the trades taking place on the ledger. These pools allow traders to execute the orders and at the same time, reward the liquidity providers with interest in a trustless and permissionless manner.
Order Book DEXs
The order book method on DEXs function similarly to centralised platforms as well as how it works on the stock exchange. You can place your order to buy or sell an asset for a specific asset pair and the algorithm will match you with someone that you can trade with.
You can also browse through the compiled records of all the open orders of the blockchain so you can comply with their terms and move forward with the transaction.
There are two types of order books on a decentralised exchange namely:
- On-chain order books
This is the most transparent approach since it does not rely on a third party to relay the orders to you. However, this also requires every node on the network to record the order on the ledger which ends up with you paying a tremendous fee.
- Off-chain order books
On the other hand, the off-chain order book is a more centralised approach since it requires a third-party host to decrease the fees you have to pay.
Aside from the above-mentioned types, the DEX aggregator can be the most useful since it uses several protocols and mechanisms to solve problems that are associated with liquidity and liquidity pools.
In essence, platforms that run on this type of DEX aggregate liquidity from other exchanges to minimise errors and slippages on the transactions. This also optimises swap fees and token prices to provide traders with the best possible price for their transactions.
Popular decentralised exchanges to know
Now that you’ve reached the end of decentralised exchanges explained, it’s time that you learn some of the platforms that are available for use. Here are some of the popular exchanges that might pique your interest:
This platform is a DEX liquidity pool that runs on the Ethereum blockchain designed for low-risk income generation for liquidity providers. It’s also an extremely efficient trading platform for stable coins because of its low slippage rate.
This platform runs on the Polygon as well as the Ethereum network which makes it a good candidate for traders. Its smart orders are powered by Ox and aggregate liquidity from multiple sources.
The IDEX platform allows users to trade with one another without giving up control to a third-party mediator because of its non-custodial nature.