What is a Decentralized Exchange? How Does it Differ from a CEX?
To properly define a decentralized exchange, we will first need to define both terms. What do we mean by an exchange? And what do we mean when we say something is decentralized?
A cryptocurrency exchange is an online crypto marketplace. It makes it possible for people to trade their digital assets securely. Examples of exchanges include Binance, Coinbase, and Coinmama.
We say that something is decentralized if it is not controlled from one central point. Usually, it is purely run by code. This is made possible through a decentralized application – a DApp in short. A human middleman does not take part in executing this code.
For some DApps, even the creators of the application that makes decentralization possible will not be able to intervene once a transaction is underway. For other DApps, developers may still be able to alter certain aspects of the Dapp, say, during maintenance.
DApps, in turn, make it possible to trade cryptocurrency pairs through smart contracts. For example, if you were to trade 0.5 ETH for 0.005 BTC, the terms of trade will be detailed in a smart contract. The exchange price, time and date of trade, values of coins exchanged and other transaction details will all be outlined in the contract. The transaction is executed automatically. Finally, the exchange will be listed on the blockchain – all without human intervention.
Therefore, a decentralized exchange (DEX) is a peer-to-peer cryptocurrency marketplace that is run by code. Here, people can interact and trade their digital assets without a need for a middleman.
How does a DEX differ from a CEX?
Centralized exchanges operate just like modern banks. A person or a group of people can set up the exchange using their private infrastructure. The infrastructure ensures that there is enough liquidity for people to buy and sell cryptocurrencies. Centralized exchanges use their own servers. The buyers and sellers come together and trade from one site.
Due to private ownership, the financial information displayed on the CEX sites and apps can be doctored. For example, trade volumes can be inflated to attract users. More users = more profits, hence there is financial motivation to cheat the market through pumping and dumping. For example, on November 5th, 2018, four exchanges participated in pump and dump schemes (see page 1618 here.)
Vulnerability to Hackers
Another drawback of centralized exchanges is their vulnerability to hackers. In 2011 and 2014, Mt. Gox fell victim to two different attacks, losing coins worth billions of dollars today. In 2018, Coincheck lost $500 million worth of NEM tokens. For almost every year that Bitcoin has existed, an exchange or two has been hacked, and people’s money has been lost.
With the host of vulnerabilities, decentralized exchanges cropped up and stepped in to solve the problems. Rather than relying on private infrastructure to enable liquidity and facilitate trading, decentralized exchanges rely on a consensus that brings buyers and sellers together.
How Does Trading Happen on Decentralized Exchanges?
For trading to be possible on a DEX, participating traders (i.e. the buyer and the seller) have to come into an “agreement” on various aspects like how much to pay for an asset. These agreements are considered to be contracts. Since the contracts aren’t in paper – but in code, they are called smart contracts.
Smart contracts are usually deployed on the blockchain for transparency. This means that whatever the buyer and the seller agree will be available for everyone on the blockchain to see. However, the identities of both parties are impossible to guess, because nobody gives their real names. Rather, only their wallet addresses can be seen.
What are the Top 5 Decentralized Exchanges?
In this section, we list the top 10 decentralized exchanges, and then we take a closer look at the top five.
Here are the top 10 decentralized exchanges:
Top 5 Decentralized Exchanges
In 2018, an engineer who used to work for Siemens founded the Uniswap company. This company pitched for and successfully received venture capital from big names like Parafi, Andreessen Horowitz, and Paradigm Ventures. It used the money to create the Uniswap protocol.
At first, the protocol was a proof-of-concept project that aimed to attract automated market makers. However, it switched from being a market maker to using liquidity pools. Centralized exchanges like Binance are market makers, because, as the name suggests, they are a marketplace for the exchange of tokens and coins. By 2020, it was a fully-fledged DEX trading hundreds of millions of dollars a day.
Uniswap has native tokens called UNI. Holders of these tokens use them to vote for changes in the protocol. Bots and people provide token pairs to the exchange, enabling others to trade since there is liquidity.
Flooz.trade is another DEX that has blossomed into a full ecosystem. Here, users can trade more than 100 verified tokens. It has an incredibly intuitive user interface that you can use to track and trade BSC tokens – and follow the growth of your portfolio. One innovative feature about this DEX is that it supports fiat deposits and withdrawals for BSC tokens.
Swapping is easy. By default, you can swap Binance (BNB) for the different tokens. The fees or gas denoted as Pew, are very low. However, depending on how fast you want the transaction to execute, you can ramp up the Pwew as much as five times.
There is a referral program for users who refer their friends to the platform. For every trading transaction that the referred person executes, the referee earns some BNB.
The platform also has a different arm for creators (flooz.link), which enables them to earn from their passion. Creators can create custom tokens of their work, and issue their own NFTs or social tokens.
The exchange has a native token, the SYA, that helps in consensus.
SushiSwap is a DEX based on the Ethereum blockchain. Liquidity providers fund the SushiSwap in equal values of token pairs. For example, the BNB liquidity providers lock equal values of ETH and BNB.
SushiSwap has its native token, SUSHI, used for voting on what direction the exchange will take when it comes to matters that require stakeholder consensus.
Additionally, users can earn more cryptocurrency by staking any earned SUSHI tokens. These tokens will earn them the xSUSHI tokens derived from the fees earned by the DEX.
DYdX is another DEX operating on the Ethereum blockchain. It picks prices from decentralized oracles such as MakerDAO and Chainlink. In 2020, the exchange introduced the maker-taker trading fees; which earn it revenue while incentivizing investors to provide liquidity to its protocol.
The exchange is working on decentralizing more aspects of its technology and giving more control to its users. It is a gradual process that may ultimately lead to a decentralized autonomous organization (DAO) to govern the ecosystem and the community.
Curve is a DEX that stands out from the pack in that it allows users to join liquidity pools using stablecoins. It does everything that a DEX like Uniswap does – with the only difference being that it focuses on stablecoins – those which have an equivalence of 1 USD or other national currencies.
Curve is a favorite for risk-averse liquidity-provider investors, who do not like potential losses caused by price slippage.
An Example of How to Trade Via a DEX: Using Flooz.Trade
As we saw above, Flooz.Trade is an excellent DEX that you can use to convert your fiat directly into crypto. To purchase tokens using fiat money, you can connect your bank account to the exchange, or use a credit card, or a service like Apple Pay. Here is an overview of how it works.
Step 1: Head over to Flooz.trade and connect your wallet
Step 1: Click “Connect” and then choose the wallet you wish to link.
Step 2: Select the crypto you wish to trade
Step 3: Swap the crypto for your target token.
That’s it! Remember to disconnect your wallet after completing the swap.
Decentralized exchanges are an exciting feature in the cryptocurrency arena. With DEXes, there is so much potential for investors to play an active role in this new form of money management. We hope that you gained something concrete from this explainer. If you have any questions, let us know in the comment section below.