How Do Decentralized Exchanges (DEX) Work?

Decentralized exchanges (DEX) platforms that offer conversion between different crypto assets. Its use does not depend on a central organization, relying exclusively on smart contracts registered in the blockchain.

DEX emulates the functions of traditional exchanges, although usually without the “Order book” with prices and quantities offered. However, there is no need for registration or KYC. The main difference from traditional (centralized) exchanges is the absence of fiat (USD, EUR, KRW) transactions.

To circumvent this issue, DEX handles stablecoins, usually paired in dollars. Therefore, there is no need for deposits or bank transfers.

How Does it Work Without the “Order Book”?

Most DEX use ‘Automated Market Maker’ protocols, algorithms responsible for pricing. Those usually consult other exchanges using oracles.

Instead of the traditional order book, where each buyer and seller set a fixed price, depositors form an asset pool. Those ‘liquidity providers’ do this in exchange for a return, known as yield.

DEX’s set of programmable contracts rebalance these baskets automatically, and the fees charged are used to compensate depositors

What is the Biggest DEX?

What is the Biggest DEX

According to DeBank, Ethereum’s DEX dominates with 70% of the total volume. However, other networks gained ground when miners’ fees exceeded $20 per transaction in May.

Uniswap is the leader and holds a 40% market share, but Binance Smart Chain’s PancakeSwap surpassed the number of transactions and users over the last four months. Curve, for example, focuses exclusively on stablecoins. Moreover, 1inch, which started solely on Ethereum, also gained relevance on the BSC network.

Is it Safe to Trade on DEX Exchanges?

Yes, because your crypto assets are never held by third parties. When you authorize the transaction through the wallet, such as MetaMask or Argent, it goes directly to the smart contract handling the trades.

However, for the liquidity provider on the depositors’ pools, there are basically two risks. First, attacks on liquidity providers can arise from flaws in DEXs’ own code. Secondly, the potential manipulation of quotes through oracles.

By relying on open-source code, hackers have time to study and find loopholes. It’s a game of cat and mouse, but it’s common to hear about some projects losing millions of dollars overnight.

Connecting a Hardware Wallet

Ledger and Trezor hardware devices can be easily connected to their Metamask wallet for users seeking an additional layer of protection.

To activate this functionality, click on the button in the upper right corner, and select ‘Connect wallet hardware.’

Connecting a Hardware Wallet

Then simply choose which physical device you have on hand and follow the instructions.

What are the DEX Advantages?

There is no need to register yourself, send documents, or similar. To use a DEX, one only needs a wallet that supports the desired network.

Another great advantage is that anyone can list crypto assets on the exchange without the need for approval.

Besides the Risks, Are There Any Downsides?

Yes. As anyone can list assets at virtually no cost, many scammers take advantage and offer fake projects for trading, using names very similar to the original.

Another problem is liquidity, the size, and the number of bids offered, which can be impacted if the price moves sharply. In traditional exchanges, it is normal for the market maker or arbitrator to act and avoid distortions. Still, in DEX, this depends on the price feed from other exchanges, which may be distorted.

Although the brokerage fee is low, there is the need to send transactions over the network, known as miner fee or gas. Ethereum congestion can cause such a fee to easily exceed $40, causing it virtually impossible for smaller transactions to take place.

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