A DEX (decentralized exchange) is an exchange that allows users to trade Cryptocurrency directly with each other without the need for a third party by using a feature called smart contracts that utilizes blockchain technology.
Since around 2020, DEX projects such as Uniswap, PancakeSwap, Curve, and SushiSwap have been launched one after another, and over the years, DEXs have grown to rival traditional Cryptocurrency exchanges (CEXs) in terms of transaction volume.
In this article, we will discuss the features of the popular DEX, how it differs from the CEX, its benefits and disadvantages, and recommended projects, etc. If you are interested in trading on the DEX, please take a look at this article.
What is a DEX (decentralized exchange)?
A DEX (Decentralized Exchange) is an exchange that utilizes blockchain to allow users to trade Cryptocurrencies directly with each other without the need for an administrator.
DEXs use a function called “smart contracts,” which automatically execute transactions based on pre-defined contracts when certain conditions are met, to create a financial system that allows fraud-free transactions to take place without the need for an administrator.
Typical DEXs include Uniswap, PancakeSwap, SushiSwap, and Curve.
Difference between CEX and DEX
There are two types of Cryptocurrency exchanges: centralized exchanges (CEX) and decentralized exchanges (DEX).
Traditional CEXs (such as Coinbase and Binance) use an order book format. The order book format uses a function called the order book (board) to match users’ buy and sell orders and execute trades.
The DEX, on the other hand, often uses an Automated Market Maker (AMM) format, in which participants are divided into two groups: Liquidity Providers (LPs) and users who wish to exchange tokens, The LP deposits the two tokens to be exchanged into the liquidity pool as a pair.
For example, assume WETH and USDC are deposited. By depositing these two tokens, a liquidity pool is created for the exchange of WETH and USDC. The rate of exchange is calculated by a mathematical formula and the price will fluctuate according to the amount of inventory in the pool.
Users wishing to exchange tokens can do so based on the tokens in the liquidity pool; in exchange for depositing tokens, LPs earn a yield as a reward. This mechanism is called “liquidity mining” or “yield farming.
In the case of CEX, transactions are processed off-chain, while DEX is unique in that it is processed on the blockchain. In addition, while CEX allows for exchange between legal tender/cryptocurrency and between cryptocurrencies, DEX only allows for exchange between cryptocurrencies, but not between legal tender/cryptocurrency and cryptocurrencies.
DEX is one of the DeFi services
DeFi (Decentralized Finance) is a generic term for financial services and ecosystems built on the blockchain. And DEX is classified as one of the DeFi services.
DeFi mainly includes the following services
- DEX (decentralized exchange)
- Lending
- Liquid Staking
- Stablecoin
- Bridges
- Derivatives
- Yield Aggregators
Benefits of DEX (decentralized exchange)
DEX offers the following five main benefits
- No need to open an account
- Global availability
- Large number of stocks handled
- Reduced risk of hacking
- Rewarded for providing liquidity
Let’s take a closer look at each of them.
No need to open an account
The first benefit is that there is no need to open an account.
DEX does not require the opening of an account, which is necessary for general CEX (centralized exchange), and can be used immediately by simply connecting to a wallet such as MetaMask. The fact that anyone can use the DEX instantly without providing personal information such as name and address is a major benefit of the DEX.
Global Availability
Second, DEX can be used globally.
Unlike the CEX, which may only be available in certain countries or regions, the DEX can be used overseas as long as you have a smartphone and an Internet connection.
Large number of stocks handled
The third point is that “many stocks are available for trading.
Since the DEX does not usually screen currency listings, it has the benefit of being able to trade minor issues that are not handled by the CEX. For example, Uniswap, a representative of the DEX, handles a huge number of tokens (over 1,500 types).
Reduced risk of hacking
Fourth, the risk of hacking is reduced.
In contrast to CEX, where the operator manages the private keys for customers’ wallets, DEX allows users to manage their own private keys, thereby diversifying and reducing the risk of being hacked.
Rewarded for providing liquidity
Fifth, “Rewards are earned by providing liquidity.
In the DEX, Cryptocurrencies used for swaps are stored in a specific pool among users, and transactions are conducted by using the tokens deposited in the pool when swapping. This specification allows users to conduct transactions with each other without involving a third party such as an operating company.
The DEX rewards users who contribute to liquidity by depositing tokens in the pool. This mechanism is called “liquidity mining” or “yield farming”.
Liquidity mining has attracted the attention of many investors as a low-risk investment method, since anyone who owns tokens can participate in the process, and in addition, it provides a steady stream of profits without losing their holdings.
Disadvantages of DEX (decentralized exchange)
While the DEX has the aforementioned benefits, it also has the following disadvantages
- No investor protection mechanism
- No customer support
- Fraudulent coins are easily listed
We will explain in turn what they are.
No investor protection mechanism
The first disadvantage is that there is no investor protection mechanism.
DEX, which provides services based overseas, does not have strict rules for user protection. Therefore, even if a user suffers a loss due to the responsibility of the DEX side, it is not possible in principle to rely on the law to seek compensation.
Customer support is not available.
The third point is that customer support is not available.
In a company-run CEX, if you have a question about a transaction, you can contact customer support to resolve the issue. However, in a DEX, where there is no centralized administrator, such support is basically unavailable.
When using a DEX, you will often see terms that require some familiarity with Cryptocurrencies, but in a DEX without customer support, you will have to look up the meaning of the terms yourself. Considering these points, it can be said that a DEX without a support system is a hurdle for beginners who have just started trading.
Fraudulent coins are easy to list
The fourth point is that it is easy for fraudulent coins to be listed.
In general, the DEX does not examine currency listings, and anyone can create and list their own tokens as long as they conform to standards such as ERC-20 and BEP-20. This has the disadvantage that “fraudulent coins” issued for the purpose of defrauding users can easily be listed on the DEX.
4 Recommended DEXs (decentralized exchanges)
Next, we will discuss the following four DEXs, which are particularly well-known due to their high trading volumes.
- Uniswap
- PancakeSwap
- Curve
- SushiSwap
Uniswap
Uniswap is a blockchain-based DEX such as Ethereum launched in 2018, and as of April 2023, it boasts the highest trading volume among all DEXs.
Uniswap handles over 1,500 Cryptocurrencies issued according to Ethereum’s “ERC-20 standard,” and users can trade 24 hours a day through a dedicated interface.
Uniswap also offers a service called “liquidity mining,” in which users deposit their own Cryptocurrencies for a certain period of time (providing liquidity) and receive “UNI,” a proprietary token, as interest.
Note that Uniswap supports the following six blockchains (as of April 2023)
- Ethereum
- Polygon
- Optimism
- Arbitrum
- Celo
- BNB Chain
PancakeSwap
PancakeSwap is a DEX launched in 2020 based on the BNB Chain, a blockchain developed by Binance, a major Cryptocurrency exchange.
BNB Chain has the characteristic of low gas prices (fees) compared to other blockchains. Therefore, PancakeSwap, which is based on BNB Chain, can also be traded at a lower cost than other DEXs.
Like Uniswap, it can also earn “CAKE” governance tokens by providing liquidity to the pool.
In addition to the BNB Chain, PancakeSwap is also compatible with the Ethereum and Aptos blockchains.
Curve
Launched in 2020, Curve is a DEX that allows for efficient trading of stablecoins such as USDT and USDC.
Curve has implemented a mechanism that allows for a smaller slit page (the difference between the price at which an order is placed and the price at which it is actually executed) when trading stablecoins than other DEXs, and the commissions are also lower.
It is also unique in that it supports a total of 11 different blockchains, including Ethereum, Avalanche, Polygon, Fantom, and Celo (as of April 2023).
SushiSwap
SushiSwap is a DEX launched in 2020 by engineers Chef Nomi and 0xMaki as a forked (copied) version of Uniswap.
Sushiswap offers services such as swap and liquidity mining, just like any other DEX. The proprietary governor’s token, SUSHI, is used for voting on exchange policy and for liquidity mining rewards.
One of the key differences between Sushiswap and other DEXs is that the tokens can be purchased with legal tender such as dollars using credit cards or Google Pay.
It is also unique in that it supports a total of 20 different blockchains, including Ethereum, Polygon, and Fantom (as of April 2023).
How to Use the DEX (decentralized exchange)
Then let’s look at how to actually use the DEX.
The general procedure to get started with DEX is as follows
- Purchase Cryptocurrencies on a domestic exchange.
- Prepare a wallet
- Transfer Cryptocurrencies to the wallet
- Connect your wallet to the DEX
Let’s look at each of these in detail.
Buying Cryptocurrencies on the Exchange
The DEX is a system for swapping (exchanging) Cryptocurrencies with each other, and it is not possible to trade using legal tender. Therefore, before using the DEX, it is necessary to purchase the underlying cryptocurrency on a cryptocurrency exchange.
For example, Uniswap, a representative DEX, supports blockchains such as Ethereum (ETH) and Polygon (MATIC), so users need to purchase these currencies as the source of the swap at an exchange in advance.
Not only Uniswap, but all major DEXs are compatible with the Ethereum blockchain, so beginners should have no problem purchasing Ethereum anyway.
Prepare a wallet
Next, prepare a wallet to store your purchased Cryptocurrencies outside of the exchange.
When swapping on the DEX, first connect the wallet to the DEX. Then, the currency stored in the wallet is traded in exchange for the tokens pooled in the DEX.
There are different types of wallets for Cryptocurrencies, and the available wallets vary from DEX to DEX. For example, Uniswap supports the following three wallets
- MetaMask
- WalletConnect
- Coinbase Wallet
Of the three, we particularly recommend MetaMask, a leading Cryptocurrency wallet. Available as a smartphone app or Chrome extension, MetaMask is versatile enough to be used on DEX and NFT marketplaces other than Uniswap.
Transfer the Cryptocurrency to the wallet
Next, transfer the Cryptocurrency to the wallet you have just prepared.
Cryptocurrencies can be transferred on the exchange’s money transfer page. Note that you will need to enter the address of the wallet to which you wish to transfer the money.
Connect your wallet to the DEX
Finally, connect your wallet to the DEX you wish to use.
This is how to start DEX. From then on, you will use the Cryptocurrencies stored in your wallet for token swapping and liquidity mining.
Please note that the swapping process and other details vary slightly depending on the DEX you use.
FAQs about DEX (Decentralized Exchange)
Frequently asked questions about DEX are presented here in a Q&A format.
What is a DEX?
A DEX (Decentralized Exchange) is an exchange that utilizes blockchain to allow users to trade Cryptocurrencies directly with each other without the need for an administrator.
Typical DEXs include Uniswap, PancakeSwap, SushiSwap, and Curve.
What is the difference between a CEX and a DEX?
In a CEX, a company operates the exchange, whereas in a DEX, users trade with each other using smart contracts.
In addition, CEX uses the “order book format” for trading using the “board,” which is also used in stock trading, while DEX uses the “AMM type (automatic market maker method),” which uses a liquidity pool.
To whom is DEX recommended?
When using the DEX, you will often see terms that you may not be familiar with unless you are familiar with Cryptocurrencies. Therefore, DEX is a service for intermediate to advanced traders who have some experience in trading Cryptocurrency.
What should I be aware of when using a DEX?
The main disadvantages of DEX are as follows
- No investor protection mechanism
- No customer support available
- Fraudulent coins are easily listed
Summary
We have explained about DEXs (decentralized exchanges).
Unlike general exchanges operated by corporations, DEXs do not have a centralized administrator, and while they have advantages such as being open to anyone without opening an account, they also have disadvantages such as the lack of an investor protection system and the ease with which fraudulent coins can be distributed.
In addition, considering the fact that you often see terms that require some knowledge of Cryptocurrencies to understand when trading, DEX is a service for intermediate to advanced traders who are familiar with trading Cryptocurrencies.