While trading on centralized exchanges is typically the first experience most users have with crypto, they are certainly not the only option available. Decentralized exchanges allow anyone to buy, sell, and swap cryptocurrencies without depending on an exchange or any other third-party. Many prefer to trade crypto using these platforms since they don’t require users to entrust their private keys and trust to an intermediary.
In this guide we’ll introduce you to decentralized exchanges and how they work. We’ll also discuss the advantages and risks of trading on DEXs and give you some relevant examples of decentralized exchanges.
Here’s what we’ll cover:
- What is a decentralized exchange?
- How do decentralized exchanges work?
- How to use a decentralized exchange?
- DEX Pros
- DEX Cons
- Best Decentralized Exchanges
What Is A Decentralized Exchange?
In simple terms, decentralized exchanges facilitate crypto trading without a middle-man. While centralized exchanges process trades for their users, DEXs are smart-contract based platforms that allow users to trade crypto directly, without entrusting their assets to any intermediaries.
Decentralized exchanges not only ensure you maintain full custody of your assets and private keys, but they also don’t require you to verify your identity or give intermediaries the power to limit, restrict or control your trades. DEX users are also able to trade at a lower cost since they can avoid some arbitrary trading fees set by centralized crypto exchanges.
How Does A DEX Work?
Decentralized exchanges run code that is able to self-execute smart contracts, so that transactions can be automatically processed without any brokers. This ensures that funds move from one wallet to another, ensuring traders obtain their assets.
There are different types of decentralized exchanges:
- Order Book: Here traders set an order with a bid or asking price for crypto, which is filled according to market availability. This can be done either on-chain or off-chain. In on-chain trades, transactions are recorded onto a blockchain. On the other hand, in off-chain trades orders are matched off the blockchain and finally settled on the chain.
- Automated Market Maker: Most decentralized exchanges belong to the AMM category. These platforms use algorithms or math formulas to set prices and facilitate trades using liquidity pools. Users are able to deposit and withdraw from these pools as they trade.
Decentralized exchanges also offer DEX tokens, which users can stake to help provide liquidity for trades and earn a share of trading commissions. With the rising popularity of decentralized exchanges, we have also recently seen some of their native tokens grow significantly.
How to use a decentralized exchange?
DEXs can be a little intimidating at first, especially for beginners. Once you have a wallet set-up and funded with crypto, all you need to do to get started is to connect your wallet to a DEX of your choice. No completion of documentation or identity verification is required. Once your wallet is connected to a DEX, you’ll navigate its interface to select the crypto pair you want to trade, set the amount and complete the exchange.
Decentralized exchange advantages
One concern with centralized exchanges is that as they handle your assets and trades for you, they have the ability of restricting your trading activities. With a decentralized exchange you have full custody of your cryptocurrencies, which are kept on your personal crypto wallet and trades are executed directly through smart contracts. You are also fully and solely in charge of safeguarding your wallet and your private keys though.
Centralized exchanges support more well-established and popular digital currencies. If you are looking to invest in a new or smaller project, you’ll struggle to find these altcoins in a CEX. Decentralized exchanges give you access to a wide variety of tokens, expanding your trading possibilities.
Decentralized exchanges allow users to trade anonymously and privately. All you need to trade on a DEX is to link your crypto wallet. This way you can avoid having to provide personal information or KYC and AML documentation to sign up and verify your account as you would on a centralized exchange.
Since centralized exchanges manage cryptocurrencies for hundreds of users, they are an attractive prey for hackers. When you hand over custody of your assets to a centralized exchange, you are also entrusting them with the responsibility of safeguarding your crypto. If the CEX mishandles your tokens or is vulnerable to threat, your investments can be compromised. On the other hand, using a DEX your assets are always in your possession, kept in your own non-custodial crypto wallet.
Decentralized exchange shortcomings
Centralized exchanges provide beginner-friendly interfaces, simple onboarding processes and plenty of educational and support resources. Decentralized exchanges, on the other hand, are less user-friendly, especially for crypto beginners who might just be familiarizing themselves with digital currencies and crypto wallets.
One of the downsides of trading on a DEX is the lack of availability of fiat currencies. You’ll have to own crypto to get started on these platforms since crypto-to-fiat or fiat-to-crypto trades are not available.
Limited Trading Types
If you are looking for advanced trading features, such as margin trading and stop losses, decentralized exchanges will not be the best choice, since many of these operations are not available in these smart-contract based platforms.
Best Decentralized Exchanges
1inch is not a DEX itself, but a DEX exchange aggregator available for non-US residents. It works by putting together price data for cryptos across multiple exchanges to deliver its users the best available price for their trades. 1inch itself doesn’t charge any fees, but you’ll still have to pay the transaction fees on the exchange used to complete the trade. You can use 1inch with a wide variety of wallets including Metamask and Ledger.
The Pancake Swap exchange uses the Binance Smart Chain and supports trading for BEP-20 tokens. Pancake uses CAKE as its utility token, which can be staked directly or through SYRUP pools in order to earn additional tokens and rewards. If you are trading on Pancake Swap, you can expect to pay fees as low as 0.2% per trade.
Uniswap is built on Ethereum and supports trades for ERC20 tokens. It was founded in 2018 and is one of the most popular examples of an AMM DEX. The platform is governed by the holders of its native token, UNI. Uniswap charges users a 0.3% fee for each trade. Liquidity providers on Uniswap receive a part of these fees in exchange for their contribution.
IDEX is a hybrid DEX that blends Automated Market Making and order-book based transactions. This allows its users to use a DEX while enjoying some of the benefits of centralized exchanges. One of the benefits IDEX provides is availability of advanced trade orders. It also allows you to complete simple swaps directly from a crypto wallet.
Atomic is a decentralized exchange that also offers its own crypto wallet and is available on the web and mobile and desktop devices. It allows its users to swap tokens across chains and supports ERC-20 and BEP-20 tokens. The exchange uses peer to peer order books and runs atomic swaps, which ensure that both parties involved in a trade receive their corresponding funds.
Decentralized Exchanges: The Bottom Line
Decentralized Exchanges allow you to trade cryptocurrencies directly from your wallet while retaining custody of your private keys. They eliminate a lot of the concerns that users have when trading on centralized exchanges, however they also come with some disadvantages, such as no fiat to crypto trades and less beginner-friendly platforms.