While centralized exchanges are the dominant player in the crypto landscape, there is no denying that decentralized exchanges are growing in popularity. Decentralized exchanges look to facilitate direct trading between users by utilizing smart contracts. However, decentralized exchanges differ when it comes to their underlying architecture.
What Is A Decentralized Exchange (DEX)?
Let’s first understand decentralized exchanges. A decentralized exchange is a peer-to-peer marketplace that allows users to make transactions directly with each other without having to hand over custody or management of their funds to an intermediary. Instead of an intermediary, transactions are facilitated through self-executing smart contracts. Decentralized exchanges were created primarily to remove the requirement of any centralized authority overseeing or authorizing transactions.
Unlike their centralized counterparts, decentralized exchanges allow users to conduct peer-to-peer (P2P) transactions, linking buyers and sellers directly. DEXs are primarily non-custodial, which means users keep control over their assets and private keys. Additionally, users don’t have to submit any personal details and identifying information such as names or addresses. This is why decentralized exchanges are preferred by those users who value their privacy.
How Do Decentralized Exchanges Work?
Let’s understand how decentralized exchanges function. As mentioned earlier, decentralized exchanges cut out intermediaries, instead facilitating transactions utilizing smart contracts, enabling users to trade directly with each other. There are three main types of decentralized exchanges, Automated Market Makers, Order Books DEXs, and DEX Aggregators. Let’s look at each one briefly.
In on-chain order books, every transaction’s details are recorded on the blockchain, such as the purchase and request to purchase and cancel orders. On-chain order books are highly decentralized. However, because every detail related to the transaction is recorded on the blockchain, they can be cumbersome and expensive.
The second type is off-chain order books. As the name suggests, these process transactions off-chain, with only the final transaction added to the blockchain. Off-chain order books offer some advantages over on-chain order books because the transactions are faster and cheaper since they are processed off-chain. However, they could present some security issues.
Automated Market Makers (AMMs) discard order books entirely, removing counterparties and introducing algorithms instead. Order books work only if the CounterParty has the asset you want and wants the asset that you want. For example, if you have Chainlink and want to purchase Compound, you will need another user who has Compound and is willing to purchase Chainlink in return. Because the price is set through algorithms, users can trade tokens regardless of whether there is another user at the end of the trade. AMMs facilitate trading through liquidity pools, incentivizing users to stake some of their funds in a smart contract and facilitate trades.
Comparing Centralized And Decentralized Exchanges
DEXs offer users several advantages, such as token availability, anonymity, reduced risks, and reduced CounterParty risks. However, most users still prefer to use a centralized exchange.
So why do most users prefer to go with a centralized exchange? There are several reasons:
- Centralized exchanges offer a significantly higher trading volume compared to their decentralized counterparts. Market watchers believe that nearly 99% of all crypto trades take place on centralized exchanges.
- Centralized exchanges also feature significantly higher liquidity.
- Centralized exchanges are extremely user-friendly, offering a seamless and simple experience for users.
- Centralized exchanges are licensed and regulated by government authorities.
- Some centralized exchanges offer users a host of other financial services, such as banking and crypto-debit cards, giving them a huge advantage over decentralized exchanges.
Decentralized exchanges offer users convenience and anonymity and have come a long way since they first appeared in 2014. While they are not as popular as their centralized counterparts, DEXs have carved a niche in the crypto space, especially with users who value their privacy and anonymity.
There are several prominent exchanges users can consider. One of the best platforms to trade cryptocurrencies is Gate.io. Check out the Gate.io crypto exchange now. Gate.io offers users an easy-to-use interface, allowing them to trade over 1400 cryptocurrencies securely and efficiently.