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What are decentralized exchanges? (DEX)


What are decentralized exchanges? (DEX)

by | DeFi

One of the primary motivations behind launching cryptocurrencies was to get rid of the centralized control of financial institutions.

While cryptocurrencies have had some success in achieving that freedom, there are some cogs within the cryptocurrency ecosystem derailing this purpose.

Centralized exchanges in the crypto industry are the equivalent of conventional financial institutions in the banking industry.

You need centralized exchanges to trade cryptocurrencies, but you give up your control of crypto assets as soon as you transfer your digital currencies to a centralized exchange wallet.

On top of the lack of control, centralized exchanges are susceptible to cyber-attacks.

Here is a list of some of the biggest centralized exchange hacks.

The solution to this problem has a name: Decentralized exchanges.

🔎 Key takeaways

  • Decentralized exchanges could provide an ideal trading environment for crypto assets, but they are in their nascent stage
  • As time progresses and more startups work towards a genuinely decentralized trading infrastructure, we’re likely to witness a greater momentum in the future
  • Hybrid exchanges offer a better alternative to their centralized counterparts

What is a decentralized exchange (DEX)?

Uniswap - Dex - Decentralized Exchange

A decentralized exchange or DEX is a platform for trading cryptocurrencies that operates on open blockchain networks, facilitating peer-to-peer trading of crypto assets.

Crypto owners hold control of their cryptocurrencies, and there is a factor of anonymity still present on DEXs.

How does a decentralized exchange work?

Decentralized exchanges are built around the core idea of everything happening on the blockchain.

Every order must be registered, matched, and settled on the blockchain, ensuring maximum transparency.

All the transactions are peer-to-peer, eliminating the need for a central party to hold the tokens or funds.

The pros of Decentralized Exchanges

  • Decentralized exchanges offer complete control to the crypto owners. They can either trade their crypto assets or spend them as per their requirements.
  • Since there are no third-parties involved, participants do not have to pay intermediary charges or settlement fees. The only fee they have to pay is gas or transaction fees.
  • Decentralized exchanges function similarly to a blockchain, making them immune to single-point failure attacks. The only possible way for a fraudulent party to alter a transaction is a 51% attack.

  • The cons of Decentralized Exchanges

  • Decentralized exchanges may lack sufficient liquidity for orders to go through quickly.
  • In the case of network congestion, transactions may take longer to settle or cost higher than usual.
  • Since decentralized exchanges are comparatively new, some users may find them slightly challenging to operate.
  • Third approach: Hybrid Exchanges

    Binance Dex Exchange

    Some other kinds of exchanges are operating successfully in-between centralized and decentralized exchanges.

    These hybrid exchanges maintain separate (centralized) order books and only register trades on the blockchain once parties are matched.

    Some examples of hybrid exchanges include Binance DEX and IDEX.

    These exchanges often operate with combined liquidity pools, connected through trusted-third parties (relayers), allowing them to have sufficient liquidity.

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