What is the last choice of traders who attach importance to anonymity and decentralization in crypto money transactions, the concept of decentralized stock exchange (DEX), which we hear frequently with both the services they provide in the DeFi world and the local cryptocurrencies they issue? What are the positive benefits or negative factors of DEXs?
Decentralized exchanges (DEX) began to be integrated into the life of the cryptocurrency investor with the expansion of the DeFi industry. Decentralized crypto exchanges such as Uniswap, Sushiswap, Venus and 1inch Exchange continue to attract investors’ attention with the products and services they offer and offer many advantages for investors who dream of a “bankless” future.
In this article, we want to eliminate the question marks about decentralized exchanges. What is DEX and how does it work? What are the pros and cons of decentralized exchanges? We share the answers to all these questions with you.
What is a decentralized exchange (DEX)?
The decentralized exchange offers its users a way to buy and sell cryptocurrency or other blockchain-based assets without a central institution or intermediary. These exchanges, which take their place in the decentralized finance (DeFi) sector, promise the investors the advantages of blockchain such as decentralization, anonymity and reliability.
With the facilities provided by DeFi, everyone who has access to the internet becomes easily accessible to banks and financial services, while DEXs take their place with liquidity providers in this system. The concept of liquidity provider, which we see in the Forex (FX) market, is generally used by buying and selling the currency in hand; It can be interpreted as making money from money. With DEXs, liquidity providers earn money from crypto money while providing liquidity to the market by yield farming with the crypto coins in their hands.
Typical centralized exchanges work in the form of “deposit your money and release control”. The term releasing control means that when you place a trade order, the exchange will execute the trade on your behalf. Trades are not made peer-to-peer (P2P), but are allocated from the exchange’s own base. Decentralized exchanges allow peer-to-peer transactions and maximize the security of funds with blockchain technology.
What is on-chain and off-chain order book?
In some DEXs everything happens on-chain and every transaction is recorded on the blockchain. This is often seen as the most transparent approach. In on-chain exchanges, you expect a validator or miner for each node to add your transaction to the blockchain, and eventually you pay a transaction cost. This model is called an on-chain order book.
Exchanges operating with the off-chain order book model are seen as central in some aspects. In these exchanges, every transaction that takes place on the network is accumulated in one place instead of being recorded on the blockchain. In this model, the authorities undertaking the role of transferring manage off-chain orders and can perform transactions between exchange users by making use of liquidity pools. In the off-chain model, the transaction in question is processed as on-chain only when the parties match. Although there is a relatively centralization situation for the off-chain model, blockchain can prevent speed and scalability problems as it is not actively used very often.
What is AMM?
Automated Market Maker, AMM, is a new alternative to the traditional market maker model with liquidity pools managed by algorithmic mechanisms. Unlike the two models above, AMM enables transactions without order books. With the AMM model, transactions can be carried out through liquidity pools without the need for a market maker.
With the AMM model, the cryptocurrency investor himself becomes a market maker by providing liquidity to the pools without the need for an intermediary. These liquidity providers can also generate income from fees in the exchange in return for their transactions. The AMM model uses a mathematical formula that instantly quotes investors, taking into account the current liquidity of a pair. The AMM model, which works with this algorithm without the need for order books to get prices, aims to solve the liquidity problem for trading pairs that are relatively difficult to swap. Currently, Uniswap and Balancer platforms use the automatic market maker model.
Pros of decentralized exchanges
Do not entrust your funds to anyone else
DEXs generally do not hold user funds. So you only have control over your own cryptocurrency. Traders who want to trade in the decentralized exchange retain control of their funds during the entire transfer period. For this reason, there is no need to worry about a negativity such as a hacking attack. Decentralized exchanges operate with a spread out network of computers rather than a center where funds are collected, so the risk of attack is minimal.
Minimum fear of collapse
While even seconds are valuable for traders in an area with high market volatility, such as the cryptocurrency sector, central exchanges that collapse or stop their transactions in times of intensity or maintenance can create problems. However, in decentralized exchanges that operate in a fully distributed manner, the possibility of stopping the transactions is minimized because the distribution does not take place from a single point. Even if some nodes are shut down due to factors such as updates, hacking attacks or technical maintenance, the remaining nodes may continue to run the network.
No creating an account
It is necessary to create an account and log in to trade on central exchanges. In a DEX, your Private Key is counted as your login information. After logging into DEX with your Private Key information, you can see your balance immediately. To use a DEX, all you need is a cryptocurrency wallet.
Since liquidity pools are created by traders in DEXs, cryptocurrencies not yet listed by central exchanges can be found in decentralized exchanges when the necessary supply and demand are seen.
Cons of decentralized exchanges
You cannot buy cryptocurrency with your money
There are no fiat currency trading pairs on decentralized exchanges. You cannot buy or trade cryptocurrencies with traditional currencies such as dollars or euros.
No customer representation
Central crypto money exchanges, which have reached a certain number of users, usually have a customer representative where they can contact their users in case of problems. While CEX users can communicate with the platform via e-mail or phone about the problems they experience, there is no such option for DEXs.
For experienced users
DEXs provide services to more knowledgeable and experienced investors by design. For this reason, decentralized exchanges can be complicated to beginners in crypto money investment. Central exchanges may be a more useful choice for inexperienced investors in the cryptocurrency industry. While users who do not have a crypto money wallet but want to invest in crypto money can easily solve this problem with CEXs, it is necessary to already have a crypto money wallet in order to trade on DEXs.
Some trading pairs on decentralized exchanges may not offer reasonable prices due to insufficient liquidity. Some central platforms, which are more popular and have more volume, may draw a relatively stable picture at this point.