A decentralized exchange (DEX) is one of the fascinating developments of the DeFi revolution. As you may already know, DeFi is a movement in which developers construct decentralized alternatives to many traditional legacy financial institutions and goods. The decentralized version of exchange, such as a crypto exchange, is commonly known as DEX.
Before we answer the “How DEXs came to the rescue of CEXs shortcomings?” question, let’s learn about centralized exchanges, decentralized exchanges, and points of differences between them.
What are centralized exchanges (CEX)?
Centralized exchanges (CEX) are platforms that allow users to purchase and sell cryptocurrencies for fiat currencies such as the US dollar or between digital assets such as BTC and ETH. They operate as reliable intermediaries in trades and frequently serve as custodians, keeping and safeguarding your assets.
While they have certain flaws, they have some advantages, as well:
- They have a high level of liquidity on a continual basis.
- They are responsible for the great majority of trade activity.
- Typically, centralized exchanges are much faster, resulting in a better user experience.
Before we move further into comprehending how DEXs is the rescuer, let’s understand what the components that make an exchange are:
- Graphical user interface (GUI): This customer-facing interface comprises everything you see as a user on the website.
- Trading engine: A trading engine, also known as a matching engine, is a piece of software that keeps track of all open orders and creates transactions when two of them match.
- Cryptocurrency wallets: When you register with the exchange, you will be given wallets for specific cryptos.
- Liquidity: Exchanges must have enough liquidity to maintain a healthy trading environment.
What are decentralized exchanges (DEX)?
A decentralized exchange (DEX) is a peer-to-peer marketplace where cryptocurrency traders may deal directly with one another. DEXs provide one of crypto’s most fundamental functions: facilitating financial transactions that aren’t mediated by banks, brokers, payment processors, or any other third party.
Some of the most popular DEXs are based on the Ethereum blockchain. They are part of a growing suite of decentralized finance (DeFi) technologies that allow users to access a wide range of financial services straight from a compatible crypto wallet.
How does decentralized exchange work?
Decentralized exchange (DEX) is simply a set of smart contracts.
(Note: Smart contracts are self-executing, automated agreements between two directly linked parties.)
DEX uses “liquidity pools,” in which investors lock cash in exchange for interest-like returns, to ease transactions and set the values of multiple cryptocurrencies against each other algorithmically.
DEX transactions are processed immediately on the blockchain, unlike centralized exchange transactions, which are registered on the exchange’s internal database.
Why choose DEX over CEX?
Before starting your trade on a centralized exchange, you must first deposit your assets in the exchange’s custody. On a decentralized exchange, you can keep your assets and have complete control over them.
With the addition of liquidity pools, decentralized exchanges offer a convenient method for crypto trading. Along with the completion of trades, the percentage of different crypto assets in the liquidity pool of DEXs fluctuates constantly. Consequently, the liquidity pool can respond to the changing market conditions by adding additional tokens that are losing value.
Eventually, liquidity providers must remove more tokens, which could lose value. However, in centralized exchanges, you would not find the possibility for impermanent loss.
Centralized organizations use centralized exchanges and are more vulnerable to system failures. Centralized exchanges, for example, might limit user access to limit losses in the case of catastrophic market collapses. Decentralized exchanges, on the other hand, have no difficulties because there are no intermediaries. Regardless of market collapses, you can always access DEXs and use your assets as you see fit.
To summarize, decentralized exchanges still have a long way to go. However, it has clearly been a more convenient alternative to centralized exchanges. For example, no KYC verification is required, nor is there any compulsion to surrender custody of your crypto assets to the exchange. As a result, decentralized exchanges, we think, have the ability to reshape the future of cryptocurrency ownership and trade.
Determining which form of exchange to use comes down to two factors: A CEX is an ideal option for you if you are primarily concerned with the convenience of use and are hesitant to have complete control over your wallet. And, if you want to save money on fees and have greater control over your money, a DEX is the best option to go.
Disclaimer: Cryptocurrency is not a legal tender and is currently unregulated. Kindly ensure that you undertake sufficient risk assessment when trading cryptocurrencies as they are often subject to high price volatility. The information provided in this section doesn’t represent any investment advice or WazirX’s official position. WazirX reserves the right in its sole discretion to amend or change this blog post at any time and for any reasons without prior notice.