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A decentralized exchange (DEX) is a peer-to-peer marketplace where people can trade cryptocurrencies in a non-custodial manner without the need for a centralized middle party to facilitate the transfer and custody of funds.
What Is A Decentralized Exchange?
Decentralized exchanges replace intermediaries like banks, brokers with blockchain-based smart contracts that facilitate the exchange of assets. Users can directly contact the other party and make the transaction.
Decentralized Exchanges Vs. Centralized Exchanges
Traditional financial transactions are very opaque and run through intermediaries and offer extremely limited insight into their actions. On the other hand, decentralized exchanges offer complete transparency into the movement of funds and the mechanisms facilitating exchange. As user funds don’t pass through a third party’s cryptocurrency wallet during the transaction, DEXs also reduce counterparty risk and can decrease systemic centralization risks in the cryptocurrency ecosystem.
How Does A DEX Work?
Different types of exchanges offer different benefits and trade-offs in terms of feature-sets, scalability, and decentralization. Order book DEXs and automated market makers (AMMs) are among the most common. DEX aggregators, which parse through multiple DEXs on-chain so it could find the best price or lowest gas cost for the user’s desired transaction, are also a widely used category.
DEXs allow a high degree of determinism that is achieved by using blockchain technology and immutable smart contracts. Centralized exchanges such as Coinbase, Binance, Kraken only facilitate trading using the internal matching engine of the exchange, DEXs execute trades through smart contracts and on-chain transactions. DEXs also allow users to maintain full custody of their funds via their self-hosted wallets during trading.
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