What is a decentralized exchange (DEX)? How does it work?

Decentralized exchange (DEX) is a peer-to-peer (P2P) service that allows direct cryptocurrency transactions between two parties.

Decentralized cryptocurrency exchanges aim to solve the problems inherent in centralized exchanges. Decentralized cryptocurrency exchanges create P2P markets that allow investors to independently store funds and trade directly on the blockchain. Users of such exchanges can directly trade among themselves without involving a third party.

Ek okuma: What is Peer-to-Peer (P2P)? How Does the Peer-to-Peer Bitcoin Network Work?

Decentralized services are monitored and controlled automatically or by participants. The security of assets is provided by distributed ledger technology (DLT). Ethereum (EtherDelta, IDEX etc.), Graphene (BitShares, CryptoBridge etc.) or other cryptocurrency based blockchain networks (Waves, Switcheo etc.) are the most preferred in the DEX field.

What’s the difference between centralized and decentralized exchange?

Identity information of users is available on central exchanges and their currencies are kept in the accounts of the service provider company. Decentralized exchanges do just the opposite.

Centralized exchanges are run by a for-profit company or individual. These types of exchanges are obliged to protect user data and transaction details. The platform fully controls the activities and makes the important decisions for the development of the service.

In contrast, decentralized exchanges are managed automatically or semi-automatically with the support of platform participants in the important decision making process. These types of platforms allow direct interaction between participants. They use distributed ledgers to store and process all data. The decentralized exchange does not store funds or user’s personal data on its servers. It serves as a platform to find matches for the sole purpose of buying or selling.

Advantages of decentralized exchanges

Many of the strengths of decentralized exchanges come from their distributed architecture and the lack of a single center of control.

Security: Decentralized exchanges do not store user assets. That’s why hacker attacks and the complete collapse of the stock market cannot lead to a loss of funds. The lack of a single point of entry through which a person can access all assets and data complicates the business of cyber hackers.

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Low risk of manipulation: Another advantage of this type of service is that the risk of price manipulation or forgery in transaction volumes is minimal due to the lack of a centralized structure within the exchange. There are no personal accounts in the decentralized exchange. No verification is required. In fact, there is no need to specify an e-mail address. Therefore, users’ personal data cannot be stolen. This structure makes distributed ledger-based services more anonymous than exchanges that require personal verification for compliance with Know Your Customer (KYC) and Anti-Money Laundering (AML).

Independence from regulations: Distributed architecture protects the exchange from intervention by local or international authorities. In centralized structures, following the regulations means that the exchange service can be blocked completely or partially. In this case, the service becomes limited in terms of location or options.

Accessibility to different projects: Unlike the central alternative, the decentralized exchange not only provides the opportunity to place orders for existing cryptocurrencies, but also allows new varieties to be created directly in the system. Thus, new startups are opened to trading with minimal liquidity without paying high fees to get a place on large platforms.

Disadvantages of decentralized exchanges

The distributed architecture of decentralized exchanges and users’ full control of their own funds pose a number of challenges.

Ek okuma: What is a Crypto Money Exchange? How Is The Bitcoin Price Determined?

Absence of data recovery: Since there is no Customer Identification (KYC) system, it is not possible to cancel the transaction in case the password is forgotten or the private key is lost. Data cannot be recovered and assets cannot be returned. Repayment and return procedures are incompatible with the distributed ledger infrastructure. Users who accidentally commit transactions or lose control of their keys cannot regain their access.

Little option: Options such as a stop loss feature, margin trading, or loan settlement are not found in most DEXs. Since most decentralized exchanges are managed by smart contracts, cryptocurrencies that do not support smart contracts cannot be traded.

For detailed information: What is margin trading? How is it done?

Low liquidity: Decentralized exchanges often have much smaller liquidity pools compared to central sites. Investors generally; They prefer centralized services where there are more instrument options, trading pairs and orders than DEX alternatives. As a result, decentralized services fall into a vicious circle: it is impossible to provide liquidity without too many investors, while there are few users due to low liquidity.

Scalability issues: A large number of people who want to trade cryptocurrencies inevitably place a huge burden on the network. Delays, increase in commissions and many problems encountered in central exchanges may emerge over time.

Lack of customer service: Decentralized exchanges by nature cannot have support services to deal with transactions or user accounts. The user who chooses this type of exchange for digital currency trading is entirely responsible for their own funds. In case of a loss of the private key or sending a wrong transaction, they cannot get help.

Limited speed: It takes time for transactions to be checked and confirmed on the blockchain. Because the transaction time depends on the miners, not the stock market. As DEXs are less popular than centralized options, users may have difficulty finding someone that matches their buy or sell orders or negotiating a good price.

DISCLAIMER: The statements contained here are not investment advice. Never trade without researching the markets thoroughly and without comments from different circles. Read the comments of the investors you trust and consult their opinions. Remember that every trading transaction involves risk. Make your own decision when taking any action. Cointelegraph cannot be considered directly or indirectly responsible for any damages or losses arising or allegedly arising from investment products or services.

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