What Is Decentralized Exchange and How Does It Work?

Any trading you do, like swapping Bitcoin for Ethereum, aren’t occurring on a blockchain, but within the exchange’s database. Hardware wallets are a secure way to store cryptocurrency and can be used with DEXs. To use a hardware wallet with a DEX, users must first connect their wallet to the exchange directly or via ConnectWallet. It’s important to note that hardware wallets are only as secure as the user’s security practices. Therefore, users should always ensure that their wallets are properly secured and regularly monitored for any suspicious activity.

On DEXs involving margin or futures contracts, Price Feeds can help ensure the correct pricing of collateral assets and the accurate processing of liquidations. Off-chain DEXs use a third-party server for matching compatible orders and maintaining a record of trades. Off-chain order books often offer lower fees than on-chain order book DEXs, but they don’t, however, have the same degree of decentralization as rival DEXs.

The US makes efforts to apply the existing legal basis, while the authorities of Singapore strive to create a new regulatory system for such exchanges. Nonetheless, there is no unequivocal position on DEXs in these countries, while still others do not regulate such platforms at all. The most popular DEXs that fall under this category are Serum and Tonic DEX, which run on Solana and NEAR blockchain protocols, respectively. In a DEX that uses on-chain order books, there are network nodes that are assigned to maintain the record of all orders. Hopefully, you now have a good idea of how DEXs work and how to start using one. You can dig deeper into your DEX of choice and see what other features you can take advantage of.

For example, say a trader needs to convert between Ethereum (ETH) and USD Tether (USDT). They will deposit their ETH into a liquidity pool maintained in a DEX and receive USDT back. The larger the pool is, the higher the liquidity and the easier it is to swap between assets.

With automated analysis of spread between user orders, the DEX thus determines the asset’s current market price and the order book’s depth. They are Decentralised finance (Defi) technologies that allow traders to swap across several exchanges in a single interface rather than visiting multiple DEXs to monitor liquidity and trade price impact. Another important feature of an AMM is that it can be programmed to offer liquidity to the market by automatically creating and filling orders for buy and sell trades.

A centralized exchange can limit your access to your crypto, restrict or halt your ability to trade it, or even fall vulnerable to hackers. Changelly DeFi Swap is a DEX aggregator that allows users to swap tokens and coins in a decentralized manner. Changelly DeFi Swap also has its own market-maker that collects liquidity from various CEXs so users get the best of both worlds and can access the best prices for their trades. The classic approach to cryptocurrency exchanges comes from centralized exchanges (CEXs). These exchanges serve as intermediaries, keeping users’ funds safe and carrying out trades for them. The main difference between a decentralized vs. centralized exchange is that centralized platforms are run by a set group of people, which gives the exchange more say and control over its users.

DeFi: The Foundation of Decentralized Exchanges

Even Coinbase, for example, as one of the leading exchanges in the world, doesn’t have much of a presence in Latin America, Africa, or Asia as of July 2021. While there are other CEXs available in these regions, it’s clear to see how difficult getting the proper licenses in various jurisdictions can be. For centralized exchanges, it’s also more challenging from a regulatory perspective due to the fact that they are custodians – entities that hold user funds. What’s interesting about ViteX is that the decentralized exchange distributes all trading fees to the community based on the amount of VX each member holds.

  • They offer several advantages over centralized exchanges, including increased security, transparency, and efficiency.
  • It is unregulated and its ecosystem is riddled with infrastructural mishaps, hacks, and scams.
  • You will see the funds in your exchange wallet change to the traded asset practically instantly as well.
  • These AMMs rely on blockchain-based services that provide information from exchanges and other platforms to set the price of traded assets called blockchain oracles.
  • An order book is a list of all the buy and sell orders for a particular asset, organized by price.

These transactions are generally settled off-chain on a centralized server the exchange operates. Users deposited their money into the exchange to trade the available coins, and the company charged transaction fees. The corporation keeps the private keys to all the crypto holdings of its clients. Up until a few years ago, the structure of a typical crypto exchange was understandably centralized. You had a heavily regulated and capitalized entity offering trading services to clients. These companies employed a set signup process often involving identity verification as part of KYC (Know Your Customer) protocols.

They share similarities with centralized exchanges like Binance and Kraken, but they are also unique in other aspects. This article will help simplify what might seem like a complicated topic by comparing the two exchange models and highlighting these exchanges’ strengths and weaknesses presently. The goal of DeFi is to challenge the use of centralized financial institutions and third parties that are involved in all financial transactions. Traders typically pay two types of fees for DEX transactions – network fees and trading fees. They complete transactions across exchanges in the fastest time possible while protecting users from price impact and reducing the likelihood of failed transactions.

CEXs use an intermediary organization to clear trades, so users must transfer their cryptocurrencies from their personal wallet to an account owned by the exchange to be able to trade. DEXs take on a non-custodial approach, where users keep full control of their funds in their self-hosted wallets. CEXs ensure that trades take place in real-time (if you establish a reasonable market price). DEXs function a bit slower as peers execute the operations in the network, but the latter take place only after the DEX miners confirm the transaction. Combined with low liquidity, such delays often cause unfavorable price slippages for the transaction parties and invite front-runners to conduct operations with the pending transaction’s data in mind. With the rise of the self-custody narrative caused by recent events like FTX and Celsius, DEXs are observing an uptick in usage.

Order Book DEXs

Such order books are identical to those found in centralized crypto exchanges, with the exception that transactions are not confirmed by a third party. These order books are thought to be more transparent than off-chain order books because they are available for everyone to see on the blockchain. Decentralized exchanges are a great tool for cryptocurrency users https://www.xcritical.in/blog/what-exactly-is-a-decentralized-cryptocurrency-exchange/ to maintain their financial sovereignty. They enable everyone to access services without discrimination which is the original ethos of Bitcoin, the flagship cryptocurrency. Order book-based decentralized exchanges function similarly to their centralized counterparts in that they maintain a record of all open orders in some form, either online or offline.

Pros and cons of using DEXs

The robot also helps ensure that someone is always available to buy or sell crypto, so people can always find someone to trade. It helps make the market for buying and selling crypto https://www.xcritical.in/ more active and easy to use. Since they’re always able to quote a price for a user, AMMs enable instant access to liquidity in markets that otherwise may have lower liquidity.

Decentralized platforms, on the other hand, use blockchain technology to operate a peer-to-peer system which gives more power back to the users, allowing complete control of their accounts. Order book DEXs are decentralized exchanges that use order books to match buyers and sellers. An order book is a list of all the buy and sell orders for a particular asset, organized by price. In addition to a higher security level, decentralized exchanges also feature increased privacy, transparency, and interoperability with other blockchain-based applications.