A decentralized exchange (DEX) is a crypto asset trading application where exchanges and other transactions take place using smart contracts instead of a centralized trading system. The fundamental difference between DEX and centralized exchanges is that they do not store user funds and do not control transactions. Funds are transferred directly from the user’s wallet, which he connects to the platform. Also, decentralized exchanges do not have a user verification process.
Decentralized exchanges are becoming more and more popular – accordingly, more and more services are being created to support working with them. One of the brightest examples is the DEX aggregator Odoswith the help of which you can determine the most profitable way to exchange tokens.
How do decentralized exchanges differ from centralized ones?
Centralized cryptocurrency exchanges (CEXs) like Coinbase, Bitfinex or Kraken are organized in a similar way to traditional exchanges. They are managed by specific legal entities that are responsible for the operation of the platform, security of users’ funds, and compliance with the law.
Therefore, the administrations of centralized exchanges have access to customer funds and can block an individual user, a specific transaction or an entire line of business such as withdrawals if necessary. In addition, each new user must undergo the identity verification procedure.
Decentralized exchanges, in turn, are not intermediaries in transactions, they do not store funds and personal information of their users. Customer identification is most commonly performed using blockchain addresses and non-custodial wallets connected to the application. Trade transactions and other actions take place via smart contracts.
How decentralized exchanges are regulated
Currently, decentralized exchanges operate in a “grey area” as legislation has not yet addressed all the nuances of the architecture of these platforms and regulators have not found effective ways to oversee them.
One of the main difficulties related to the regulation of decentralized exchanges is that they are often not affiliated with specific legal entities and do not belong to any jurisdiction. For some DEXs, even their creators do not reveal their identities, making it difficult to determine who is responsible in the event of a breach.
What are the advantages of decentralized exchanges?
Most of the strengths of decentralized exchanges stem from their distributed architecture. Here are some key benefits:
- extremely simple trading interface;
- complete anonymity of clients, since registration, opening a personal account or verification (KYC) with personal data is not required to work with DEX;
- DEXs do not store user crypto assets, so neither the exchange developers nor the authorities can freeze funds on user accounts or impose other restrictions;
- new assets are immediately listed on the DEX as the corresponding liquidity pools are replenished;
- the possibility of passive income for users by contributing assets to the liquidity pools;
- DEX users can participate in governance by farming a governance token.
Thus, decentralized trading platforms give users full control over their funds, but at the same time full responsibility for their actions.
Prospects for decentralized exchanges
Decentralized exchanges using AMM technology have gained the recognition of millions of users, attracted tens of billions of dollars in investments and have become an integral part of DeFi and the cryptocurrency market in general.
Additionally, a number of centralized exchanges have launched their own DEXs or implemented some of their individual features. In September 2020, the largest cryptocurrency exchange Binance launched the Binance Liquid Swap service based on AMM technology. This service allows users not only to exchange dozens of cryptocurrencies, but also to place their assets in liquidity pools and receive a share of trading commissions.
In the future, decentralized exchanges should be expected to expand functionality for traders and improve interoperability for easy, cheap, and fast asset exchanges across different blockchains.
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