What is a Decentralized Crypto Exchange – Benefits & Features

In the crypto industry, the term “Decentralized Crypto Exchange” (DEX) evokes images of innovation, connection, and nonstop transactions. But what exactly is a DEX, and why is it such an important component of the booming crypto industry? 

This article delves into their significance by addressing common questions like “What is dex?” and “What does DEX do?” On top of that, we also explore how DEX works, its features, benefits, and the common types to expect. 

If you’re a beginner who’s been looking to understand this crypto industry buzzword, this article is the full expose you need. On the other hand, if you have some bits of knowledge about this discussion, this article is the refresher course you need to sharpen your understanding. 

Whichever category you fall in, you’re definitely in for a treat! 

What is a Decentralized Exchange (DEX)? 

A decentralized crypto exchange is a peer-to-peer marketplace or platform specifically built to allow crypto traders to buy and sell cryptocurrencies without having to go through intermediaries. In this sort of exchange platform, there is no centralized authoritative party overseeing or authorizing crypto transactions, as there is in centralized exchange platforms. Instead, there is an equal distribution of power between the participants (i.e., buyers and sellers).

As such, they are one of the major institutions leveraging the power of blockchain technology to fulfil the core promises and goals of blockchain technology in the financial industry: decentralization. They facilitate transactions without the need for legacy financial institutions and systems like banks, brokers, payment processors, or other intermediaries. 

Decentralized crypto exchange platforms use blockchain technology’s smart contracts to facilitate peer-to-peer trading instead of matching buyers to sellers using central servers. These smart contracts self-execute under pre-set conditions, thus conferring authority on only the buyers and sellers in a trade. As long as both parties fulfill their obligations, the transaction is processed and recorded on the blockchain.

Therefore, they are more secure compared to centralized exchanges because they have less vulnerability to hacking. It is also worth noting that decentralized crypto exchanges are non-custodial in the sense that buyers hold on to their private keys during transactions. But, for now, the idea that DEXs facilitate peer-to-peer crypto trading pretty much answers the question. “What is DEX?” To get a deeper understanding of how these non-custodial trading platforms perform their functions, we have to break down how DEX works, and we do that below. 

Strap in! 

How does a Decentralized Crypto Exchange Work? 

Firstly, unlike centralized exchanges, DEXs strictly facilitate crypto-crypto exchanges. This means that traders can only swap a particular crypto asset, such as Bitcoin (BTC), for another crypto asset, such as Ethereum (ETH). They do not facilitate crypto-fiat exchanges, i.e., exchanging fiat currencies like USD for Bitcoin (BTC). 

With that understanding, here’s how DEX works. 

A DEX uses smart contracts and blockchain technology. These self-executing programs (smart contracts) automate the trading process by facilitating the exchange of different cryptocurrencies. 

For context, the principle is kind of like how escrow accounts function. 

During an exchange, users send their crypto assets to the smart contract, which then matches different buy and sell orders with other crypto traders. When it finds a match, the smart contract triggers the exchange only when both parties have satisfied the transaction requirements. 

This way, crypto traders around the world can swap their crypto assets with other crypto traders as long as both parties agree to the conditions of the trade, and the smart contract executes it. 

If you’ve been curious as to what does DEX do, this is it. But what attributes do these platforms possess that enable them to perform this function? 

You’re about to find out. 

Features of Decentralized Crypto Exchanges (DEXs)

The following are the essential features of decentralized exchanges, enabling them to facilitate peer-to-peer crypto trades. 

1. Non-custodial Trading 

As part of the premise of eliminating centralized control, decentralized exchanges let traders maintain responsibility and control of their private keys when trading. This implies that these platforms do not access a crypto trader’s passphrases or funds. Instead, they let users trade directly from their wallets through smart contracts. This way, users can swap their crypto funds directly without first depositing them into the DEX platform. 

2. Peer-to-Peer Trading 

By ensuring that traders don’t have to deposit their funds first into the exchange, DEXs facilitate peer-to-peer trading. This means that traders from different countries can trade directly with one another without intermediaries dictating the terms of the trade. This format reduces the risk of fraud and manipulation, as transactions occur between the user’s wallets, and nothing occurs without their authorization. 

3. Decentralized Smart Contract Protocols

Decentralized smart contract protocols are the core piece of technology facilitating these peer-to-peer trades. They are built into blockchain technology to automate the trading process. As such, they ensure transparency and eliminate the need for intermediaries. 

4. Automated Market Makers 

Instead of the traditional order books used in centralized exchanges, decentralized exchange platforms use the algorithmic mechanisms of automated market makers (AMMs) to facilitate the permissionless exchange of digital assets. AMMs use liquidity pools where different users supply different crypto assets into the “pool” to facilitate smoother and faster trades. 

The idea of decentralized exchanges is to facilitate direct trades between different users. However, sometimes, few traders are ready to exchange assets on a DEX, meaning that some traders might get stranded and not find others to trade with when they need to make an exchange. 

AMMs solve this problem with liquidity pools, as liquidity providers contribute crypto assets, and AMM’s algorithm mathematically sets the prices of these tokens. This way, there’ll always be crypto assets for anyone to trade with at all times. This is a vital feature that has sustained the decentralized exchange platform model for a long time. 

5. Decentralized Storage Solutions

Although a decentralized exchange doesn’t serve as an intermediary during crypto transactions, the platform still provides some services to facilitate the exchange. For instance, these platforms still make provisions for storing vital user data and transaction records. 

However, the difference is that DEXs keep this data spread across different locations and computers instead of in one central place, as in centralized exchanges. The system splits the user files into smaller bits and distributes them across various computer networks, resulting in a lower risk of information loss or theft. 

Most DEXs use the following decentralized storage options: 

• Interplanetary file system (IPFS) 
• Filecoin
• Storj
• Sia
• NextCloud
• Arweave

6. Crosschain Compatibility 

Decentralized exchanges facilitate trades across different blockchain networks. This feature is vital because most traders might want to exchange a number of crypto assets with one another. Therefore, most modern DEXs incorporate cross-chain bridges to facilitate cross-chain crypto transactions. 

Benefits of a Decentralized Crypto Exchange

By now, we are familiar with some of the essential features that make decentralized crypto exchanges function as they do. 

But why are these unique exchanges important to crypto traders? 

The following are some essential decentralized exchange benefits.  

1. Autonomy and Privacy

We established earlier that decentralized exchanges were non-custodial. This gives the users more autonomy over their funds and how they manage their crypto portfolio. The ability to trade as you please without seeking approval from a centralized body is one of the reasons that spurred the development of blockchain technology, and DEXs offer that unique advantage. 

Since the DEX doesn’t hold funds or private keys for any user, there’s usually no need to mandate users to follow KYC and AML requirements. As such, it confers a certain level of privacy that most users seek today. 

2. Ability to Trade More Assets

DEXs’ cross-chain compatibility allows all kinds of assets to be traded on these platforms. Centralized exchanges do not have this luxury because they like to control the cryptocurrencies they list and support on their platforms to boost their profitability. So, they often choose established crypto assets with more trading activities and prevalence. This leaves out many emerging altcoins and consequently limits financial inclusion. 

Top decentralized exchanges do the opposite. They facilitate the trading of a wider range of assets, from altcoins and stablecoins to any other category of digital assets. Therefore, users have more flexibility and options when trading. 

3. Improved Security 

By their very nature, decentralized exchanges don’t have a single point of failure where everything can go wrong. Each user is in control of their own funds and private keys because the platforms are non-custodial. Likewise, even the transaction details and user data that the platform stores are distributed across various computer networks and locations. 

As such, DEXs are highly resistant to cyber threats and malicious activities. 

4. Reduced Market Manipulation

This is an extension of the security benefits of decentralized exchanges. In settings where a single entity controls the entire trading platform, it is relatively easy for certain actors to pull off manipulative trading activities like wash trading or fake trading. 

However, the decentralization of trading responsibilities across mechanisms like AMMs and different users makes it difficult to pull off these malicious activities. Additionally, most DEXs have in-built anti-manipulation features and systems like the commit-reveal mechanism, which help to keep things fair across the board. 

Basically, DEXs have been built to allow only genuine users to trade their assets and move on. 

5. Trading Efficiency 

This extreme focus on bringing traders together and facilitating seamless transactions between them simply works! DEXs are a sustainable alternative to traditional financial systems, and they are highly transparent and fair to all parties involved. 

If someone wishes to trade their crypto assets, they pop onto a DEX that simply matches them with another genuine entity with matching trading requirements. As long as both parties fulfill their transaction obligations, the smart contract executes the trade. 

End of story! 

6. Lower Fees 

This is a benefit that most crypto traders love! 

The fact that DEXs function through self-executing smart contracts allows them to charge less on average compared to centralized exchanges. In fact, some decentralized exchange platforms charge as low as 0.3% of the transaction volume. 

Nonetheless, these fees may fluctuate with the platform’s usage traffic. 

Types of Decentralized Crypto Exchanges 

While almost all decentralized exchanges function based on similar principles, some subtle differences separate them into different categories. The following are the types of DEXs available for peer-to-peer trading today: 

1. Automated Market Maker DEXs 

We hinted at these earlier as one of the features of decentralized exchanges. 

Some of the best crypto trading platforms use mathematical algorithms to automatically set the prices of crypto assets before a trade commences. After setting the prices, the system also matches buyers and sellers with similar trading conditions so that the trade can be executed quickly and smoothly. 

Instead of relying on traditional order books where sellers and buyers match prices, AMM DEXs rely on liquidity pools that liquidity providers supply. As such, you’re essentially buying or selling tokens from these pools when trading at these types of DEXs. 

This model helps to maintain liquidity and provides dynamic pricing based on market demand. Popular examples of AMM DEXs include UniSwap and SushiSwap. 

2. DEX Aggregators

DEX aggregators combine liquidity from multiple decentralized exchanges to ensure that traders don’t have to manually go through the stress of finding the best price for a token. Their focus is on helping traders find the best trading conditions. 

Here’s how it works: 

When a trader initiates a trade, the DEX aggregator scans various other DEXs to find the perfect price. Sometimes, it may even split the trade across several exchanges to minimize cost and slippage. DEX aggregators use multiple protocols to facilitate these trades. Popular examples of DEX aggregators include 1inch and Meta DEX Aggregator, which further enhance liquidity coverage by aggregating other aggregators. 

3. Off-Chain and On-Chain Order Book DEXs 

These are a lot like centralized exchanges because they match buy and sell orders using an order book. However, unlike centralized exchanges, these DEXs store the orders on the blockchain until a compatible counterparty becomes available. Once the trade is matched, the final settlement is recorded on the blockchain. 

The difference between on-chain and off-chain order book DEXs is that on-chain order books manage all trades directly on the blockchain, while off-chain order books do so outside the main blockchain. These DEXs facilitate crypto trades without taking custody of any tokens—just the orders. 

Conclusion 

Decentralized crypto exchanges (DEXs) are not just about crypto trading; they represent a symbolic shift from traditional finance that many have been clamoring for. 

Their setup reflects and shapes the future of the financial system that blockchain technology promised — the ability to execute trades and transfer value without going through a centralized body. They are an avenue for shared financial responsibility and the elimination of single points of failure. Yet, they offer a greater level of security and lower fees than most other traditional financial systems. 

By leveraging this blockchain technology, decentralized exchange development provides an avenue for individuals like you to play a more active role in the financial system. All those benefits are up for grabs, and there’s no single authoritative body to go through before claiming them. 

With the help of our cryptocurrency exchange development company, you can take advantage today! 

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