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What is a Decentralized Exchange?

Jaiya Gill
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What is a Decentralized Exchange?

A key part of DeFi is decentralized exchanges, where billions of dollars in trades happen daily. By learning how to use them, you get complete control over your assets and can save significant fees.

What are Decentralized Exchanges?

What do they do, and how can we use them?

Before we dive in, in order to understand DEXs, it’s important to understand DeFi. Here’s a quick refresher: DeFi is a set of protocols (apps) that utilize the blockchain to replicate traditional banking services in a programmatic way. Rather than an institution making decisions on who deserves these services, the decisions are built into code.

A Decentralized Exchange (aka DEX) is a blockchain application that allows you to trade your coins (just like you would on Coinbase) without the need for a middleman, all thanks to smart contracts.

Smart contracts are coded programs that allow two people to enter into an agreement, without needing to know each other, and trust that the agreement will take place. They are like legal agreements but written in code. They only execute if both parties do what they agreed to. If either try to do something fishy, it won’t allow them to or returns the money back to the other person.

In a scenario where you trade on Coinbase, Binance, or Robinhood, you trust that the platform will make good on your trade and fulfill the price. With DEXs, this happens with code. The code cannot be changed (it’s immutable), and can be audited by anyone (it’s open source).

Decentralized Exchanges are beneficial for a number of reasons including:

  1. They are typically much faster than Centralized Exchanges (CEXs)
  2. Charge you a smaller fee
  3. Don’t go down for maintenance (unless the chain goes down itself)
  4. They are open for anyone to use

Decentralized Exchanges do also have some limitations. These include:

  1. They only allow you to trade in between cryptos (no trading back direct to USD)
  2. These cryptos have to be on the same blockchain
  3. They require gas fees to use them
  4. They don’t guarantee liquidity for the trade

DEXs can be less beginner-friendly, as trades cannot be reversed, and they don’t have support teams to help you in the event of a problem. DEXs let you trade any coin in existence on that chain, without gating access to specific ones, so make sure you know what you are buying.

In order to use a Decentralized Exchanges, you’ll need to have funded a non-custodial wallet like Rainbow or Metamask. You’ll use this to log in to the site you choose to use (like Uniswap or Sushiswap) and make trades with it.

Keep in mind that Decentralized Exchanges are limited to the blockchains they exist on. For example, a DEX on Ethereum (like Uniswap) will only allow you to trade assets that exist on Ethereum, and not on Solana, Avalanche, Fantom, or other blockchains. If you want to trade between cryptos on different blockchains, you would have to use a bridge.

Using a Decentralized Exchange

You don’t need to sign up, you’ll just have to use your own wallet.

To start, you will need to:

  1. Decide which network to use (like ETH)
  2. Choose a wallet compatible on that chain (like Rainbow or Metamask)
  3. Fund it with a stablecoin or another asset (like $ETH)
  4. Trade with a DEX on that network

Popular Examples of Decentralized Exchanges

Ethereum

Uniswap: a permissionless and trustless protocol for trading and automated liquidity provision on Ethereum.
Sushiswap: a comprehensive, decentralized trading platform for the future of finance.

Solana

Serum: a permissionless protocol for decentralized exchanges that brings unprecedented speed and low transaction costs to DeFi.

Avalanche

Trader Joe: a one-stop decentralized trading platform on the Avalanche network.

Terra

Terraswap: a decentralized protocol for seamless access to asset liquidity on Terra.

You can also use 'DEX aggregators' to hunt for the most optimal trades on that chain like Matcha and 1inch Network.

How do Decentralized Exchanges work?

Many DEXs use the Automated Market Maker (AMM) model instead of the traditional 'order book' model.

This is a much more complex topic, so to keep things simple, we will discuss it at another time.

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