The whole point of using cryptocurrency is to make the usage of money decentralized. In essence, it eliminates the intermediaries like banks, brokers, payment processors, etc. By doing that, it makes the transactions anonymous, safer, and faster. But that’s not the way crypto has been implemented so far. Especially when all the major exchanges operating in this space are fully centralized. They facilitate the transactions of blockchain-based assets, but they also retain control. And for that reason, the decentralized exchanges have become very valuable among crypto users.
Decentralized Exchange: In A Nutshell
Decentralized exchange is a peer-to-peer marketplace where users can trade in cryptos without any intermediaries. These platforms act in a non-custodial manner as they only facilitate trade without maintaining any records.
They operate on blockchain and focus on maintaining its efficacy and security. Compared to their centralized counterparts, these platforms deliver more transparency. Moreover, they become safer with the absence of any counterparty risk. Decentralized exchanges become the base of the decentralized finance ecosystem.
Insights Into the Working of DEXs
The decentralized exchanges come with different structures and each of them offers distinct benefits. There are two types of fees that DEX users have to pay- trading fees and network fees. The trading fee could be collected by the platform, token holders, or liquidity providers.
These entities may even charge the users together based on the predetermined arrangement of the protocol. On the other hand, a network fee is paid for the gas utilized on on-chain transactions. So users pay it only to the exchange.
All the DEXs aim to provide an end-to-end structure and permissionless access to assets. They also distribute administrative rights among a community of stakeholders. Every member of the community has the right to vote on major decisions of the protocol. However, it should be noted that keeping the governance decentralized and efficient simultaneously is quite a challenge.
In the centralized setting, the core development team makes all the decisions related to protocol functionality. The administrative decisions are made by the stakeholders, which are usually selective individuals. But in a DEX, everyone becomes a part of the decision-making process.
While it democratizes the whole scenario, it poses some challenges too. At this point, the types of decentralized exchanges must be discussed as well.
Two Types of Decentralized Exchanges
Both variants come with different features and help users experience decentralization.
Automated Market Makers (AMMs)
AMMs are the most widely-used variant of DEX due to some notable highlights. First of all, they give equal access to everyone to liquidity provision. They also offer instant liquidity to all the users. On top of that, they make permissionless market creation possible too. An AMM uses a liquidity pool to quote a price between the assets. The liquidity pool is managed by a separate algorithm.
Order Book
An order book acts more like a facilitator for matching the buy and sell orders. It hosts an internal system that maintains the real-time collection of open orders. With the advent of Layer-2 solutions, these exchanges have become more efficient. Some popular DEXs following this system are Serum, dYdX, Loopring, and Ox.
The crypto community is hoping that DEXs get more scalable in the future. Their penetration in different spaces would make cryptocurrency a more mainstream solution.
Nancy J. Allen is a crypto enthusiast, with a major in macroeconomics and minor in business statistics. She believes that cryptocurrencies inspire people to be their own banks, and step aside from traditional monetary exchange systems. She is also intrigued by blockchain technology and its functioning. She frequently researches, and posts content on the top altcoins, their theoretical working principles and technical price predictions.
Nancy J. Allen is a crypto enthusiast, with a major in macroeconomics and minor in business statistics. She believes that cryptocurrencies inspire people to be their own banks, and step aside from traditional monetary exchange systems. She is also intrigued by blockchain technology and its functioning. She frequently researches, and posts content on the top altcoins, their theoretical working principles and technical price predictions.
Source: https://www.thecoinrepublic.com/2023/11/16/everything-to-know-about-decentralized-exchange-and-its-scope/