5 Things You Need to Know About DEX (Decentralized Exchange)
If you’re a human living on planet earth who’s ever had an interaction with the internet, you’ve most likely heard of cryptocurrencies before. Maybe you’ve been following crypto news recently, and have even thought about hopping on the trend, but it kind of scares you. As of 2021, there are 6000 different cryptocurrencies, all being traded on different exchanges, some generating over $31 billion every 24 hours (Binance). It all seems pretty overwhelming - we get it.
However, crypto is one of those things that go smoothly if you have the necessary knowledge to make informed decisions. That’s why we’re going to be talking about Decentralized Exchange (DEX) today. Decentralized exchanges are truly promising uses of blockchain technology, though they only currently represent a fraction of total crypto trading volumes. DEX’s future has exhilarating perspectives: the decentralized exchange with the most market share, Uniswap, trades over $2 billion every 24 hours. So, what are these famous DEXs all about, and what is their role in the crypto space? More importantly, what should you know about them? Let’s dive right in.
What is a decentralized exchange (DEX)?
Let’s start with the simplest definition possible. A decentralized exchange (also known as its acronym, DEX) allows transactions to happen directly between crypto users through what is called a peer-to-peer marketplace. Therefore, DEX carries out crypto’s most essential concerns: facilitating financial transactions that fulfill one of crypto’s core possibilities: fostering financial transactions that aren’t overseen by institutions, brokers, banks or any middle man whatsoever. You’ll notice that the most popular DEXs use the Ethereum blockchain, like Sushiwap, Uniswap, and PancakeSwap.
The history of DEX
Bitcoin was a revolution, back in 2009 when it took the world by storm: it was the first ever currency controlled by no one. Satoshi Nakamoto’s vision rippled and prompted others to create their own cryptocurrencies across the globe. This rapid evolution begged for different systems that would allow users to trade cryptocurrencies. The first cryptocurrency exchange, Bitcoinmarket.com, paved the way for many other fast-growing exchanges. It was now easy for users to trade crypto thanks to these platforms.
However, a burning question arose: weren’t these crypto exchanges going against the very essence of crypto? Weren’t these centralized and controlled platforms just basically like banks? Regulated and ruled by the entities they had been created by? Some even saw a complete antithesis to Nakamoto’s original ideology. To make matters worse, traders actually had to completely relinquish control over their crypto to use the exchanges, and a series of unfortunate events showed that these centralized exchanges were a truly easy target for hackers. Something had to be done.
On the 3rd January 2014, the NXT Asset Exchange was launched: this would be the first-ever decentralized exchange (DEX). Quickly after, Counterparty would launch their own DEX, followed by Block DX, a decentralized exchange that looked more like what we know today.
5 things you should know about DEX
There are 3 common types of DEX
Though there are three, each different type of decentralized exchange allows for users to trade between themselves using smart contracts. Let’s go over the three different types of DEXs.
Automated Market Makers or AMMs
The first type of DEX we’ll be going over today is the Automated Market Maker, also known as AMM. The AMM system utilizes smart contracts to offer solutions to liquidity problems, leveraging blockchain services to get the information off exchanges and platforms, allowing it to set its price for the traded assets. These blockchain-based services are usually referred to as blockchain oracles.
In AMMs, the smart contracts leverage liquidity pools which are pre-funded pools of assets that are basically the central nervous system of AMM-based DEXs. They work by allowing users to feed funds into the pools and reap rewards when pairs are traded by earning transaction fees. These users are known as liquidity providers, and they are to deposit assets in trading pairs if they want to mine liquidity and earn interest on their crypto investments, or assets. Traders are also able to execute orders in AMM-based DEXs, earning interest without the need for an intermediary.
The downside is that these AMMs also have astounding slippage, because of a lack of liquidity. The buyer ends up paying more than the market price, so bigger orders will have higher slippage. Traders that invest in liquidity pools risk impermanent loss because of how volatile one asset is in each trading pair.
Nevertheless, the AMM DEX is a prominent one, and its most popular applications include Uniswap, Sushi, Curve, or even Bancor.
Order Book DEXs
Order book DEXs are probably among the earliest applications of decentralized exchanges. They keep records of every single open order for the purchase and sale of specific pairs of assets. There are two main sub-divisions of order book DEXs:
On-chain order books
Off-chain order books
The most popular examples of order book DEXs today are Loopring, Gnosis Protocol, and IDEX.
Decentralized Aggregators
Decentralized Aggregators are more or less trading protocols that operate by routing and sourcing liquidity thanks to different DEXs on the basis of precise requirements. DEX aggregators don’t need servicing traders from their own liquidity pools, so they could become a key player in future crypto trading approaches. Some examples include 1inch, 0x, Matcha, or Slingshot.
There are benefits of using DEX…
Great variety of tokens
Those interested in budding tokens will love DEX for its great variety of tokens. It has an often quasi-unlimited range of tokens.
Reduced security risks in some cases
DEX doesn’t control users’ funds, which makes for added security and reduced risks.
Anonymity
You don’t need to input any personal information whatsoever when you use the most popular DEXs.
Low counterparty risk
Counterparty risk is when one party doesn’t fulfill their part of a transaction. DEX uses smart contracts to be free of any counterparty risks.
...And risks of using DEX
Specific knowledge is needed
DEX isn’t something you just dive into. Users need basic knowledge of security-related concepts to protect their funds, as well as knowledge regarding wallets and which are right for each token.
Token listings aren’t verified
In DEX, anyone can list a token, which can lead to rug pulls. You should definitely research tokens before you decide to invest.
User interfaces are sometimes more difficult to navigate
DEX interfaces aren’t easy to navigate, which can lead to mistakes. Look for off-site walkthroughs to get help in understanding the DEX before you use it.
There are risks surrounding smart contracts
There can be exploitable bugs in smart contracts which can lead to security breaches.
There are varying DEX fees
Every different decentralized exchange charges varying fees. For example, Uniswap charges a 0.3% fee that will be split between liquidity providers. However, bear in mind that other fees can incur, such as gas fees to use the Ethereum network or protocol fees that could be added at any point.
There are requirements for a DEX to work properly
You’ll definitely need to purchase a reasonable supply of Ethereum to be able to start trading on DEXs. You can purchase this from Coinbase or other exchanges. You need ETH (Ethereum) to be able to trade on a DEX because you’ll need “gas fees” that are required for any transaction on the Ethereum blockchain, separate from any DEX fees.
The bottom line
Decentralized exchanges are a powerful promise for the future. They first appeared in 2014, and today they allow users to trade billions of dollars worth of crypto daily. If you’re interested in DEX, we advise you to perform sufficient amounts of research beforehand to ensure that you’re not making any mistakes. It does take some knowledge to use decentralized exchanges, so don’t be afraid to gather some information before you take the leap. Here at NetObjex, our passion is helping users navigate the challenges and reap the rewards of crypto. We’d love to help you discover our platform: visit our website for more information.