If you’re a cryptocurrency user, you’ve probably wondered how funds are transferred from one wallet to another. While the term peer-to-peer transactions gives you an idea of how it works, there’s still an intricate web of information that you need to know before you can fully grasp how crypto transactions are exchanged between users.
Exchange sites are platforms where crypto users can exchange, buy and trade their digital assets. They enable fast, seamless and cost-effective exchange that lets you have your tokens in a matter of minutes or even seconds. These exchanges play a huge part in the growth of cryptocurrencies because they give people access to assets.
However, the issue with exchange sites is that they are managed by private companies that add expensive exchange fees to users. Moreover, they require users to submit personal information that they store on the central server, making them vulnerable to cyberattacks. This is where decentralized crypto exchanges come into play.
What are decentralised exchanges?
In essence, decentralised exchanges are platforms that give buyers and sellers the chance to interact without the interference of intermediaries and middlemen. Because of its decentralized nature, it eliminates the chance of price manipulation and the leak of user information when the system is destabilised.
These non-custodial exchanges heavily rely on smart contracts that self-execute once the conditions set by the parties involved in the transaction are met.
How does a DEX work?
Here are some of the concepts about decentralization that explain how decentralized exchanges work:
On-chain order book
Decentralized exchanges use on-chain order books that are tasked to keep track of the records of orders in the network. Additionally, on-chain order books also need miners to operate them and verify transactions.
Off-chain order book
Off-chain order books are the opposite of on-chain ones. In this type of order book, all the transactions are logged in a centralized network where ‘relayers’ manage the flow of transactions. Some of the most popular DEXs that use this type of order book are Binance DEX, OX and EtherDelta.
Automated market maker (AMMs)
Automated Market Makers or AMMs are features you can find in decentralized finance that enables the permissionless execution of transactions through the utilisation of liquidity pools. Since AMMs do not rely on traditional market selling and buying of assets, it’s easier to facilitate transactions.
AMMs use liquidity pools that allow the easy conversion of one asset to another without changing the market price of the asset being traded. Decentralized exchanges used to suffer in terms of liquidity because there were not enough assets to handle massive volumes of transactions. To solve this problem, liquidity pools are created.
Liquidity pools are basically a pot of digital tokens from users. All the tokens present in the pot have different prices determined by a mathematical formula. DEX exchanges that use AMMs can easily integrate them through wallets like MetaMask or Trust Wallet.
Here’s the mathematical formula used for liquidity pools:
tokenA_balance(p) * tokenB_balance(p) = k.
There are different types of AMM variations depending on the type of decentralized exchange or DeFi. For example, Uniswap allows users to form a liquidity pool with any ERC tokens with a 50/50 ratio. Meanwhile, Curve Finance can create a liquidity pool with any similar stablecoin assets and offer the lowest possible price for users.
What are the advantages of using decentralized exchanges?
Security
One of the most common disadvantages of centralized exchanges is hacking. Once the system is breached, it can compromise the safety of users’ assets. The most popular breaches in centralized exchange sites include Mt Gox, Bitfinex and Coincheck.
Because decentralized exchanges are non-custodial, they’re not prone to hacking. Keeping hackers out is easy because users can trade using cold or hot wallets. Non-custodial wallets are storages that are not managed by any central authority.
Additionally, since DEX users don’t need to use recovery seeds, they’re the ones responsible for maintaining their accounts. However, the drawback of this non-custodial feature is that when a user loses their account, there’s no central authority to help them retrieve their credentials.
It ensures privacy
All centralized exchanges have KYC protocols that require users to provide their personal information. This poses a great problem because this information can be used for unauthorized means when the system is breached.
What DEXs eliminates is the susceptibility to these breaches because they don’t ask their users for information. If you’re a user who champions privacy and security, DEXs are a good option for you.
No one controls your funds
Another exciting feature of DEXs is that they give users full control over their accounts and assets. DEX users have full custody of their crypto assets and can access them anytime they want. Issues such as account freezing and blocked withdrawals are eliminated in decentralized exchanges.
Different types of Decentralized Exchanges you should know
There are a lot of decentralized exchanges you can find in the market. If you’re interested to use them, here are some of the top DEXs we can recommend to you:
1InchExchange
1InchExchange is one of the most popular decentralized exchanges that have a swap feature, limit order feature and yield farming. What makes this exchange unique is that you can connect your wallet to the system and use it without the need to provide any personal information. You can access 1InchExchange across devices such as your phone, laptop and tablet.
Uniswap
Uniswap is another non-custodial platform built on the Ethereum network. This exchange can facilitate automated transactions for different cryptocurrencies. One of Uniswap’s unique features is that users can become liquidity providers in the network.
Pancakeswap
Pancakeswap is one of the most popular decentralized exchanges in the market that offers a lot of decentralized features for crypto users. Released as a project of the Binance smart chain, Pancakeswap allows users to swap tokens, participate as liquidity providers and stake tokens to the liquidity pool to farm new tokens.
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