Explainer

What Is A Decentralized Exchange (DEX) and What Are Its Pros & Cons?

Learn what a DEX is, how it’s used, how much its fees are, and what its pros and cons are.
Average read time:
5
minutes
Key Takeaways
  • DEX stands for Decentralized Exchange. It is a peer-to-peer (P2P) marketplace where transactions happen directly between crypto traders and purely in cryptocurrencies.
  • DEXs helps support financial transactions without any interaction with middlemen, like banks and payment processors, which is one of the original beliefs Satoshi Nakomoto stated in the Bitcoin whitepaper.
  • DEXs are one of the pillars of Decentralized Finance (DeFi) and it’s even suggested by some that DeFi wasn’t properly established until Uniswap aided in spotlighting the sector during the summer of 2020, otherwise known as ‘DeFi Summer’.

How does a Decentralized Exchange (DEX) work?

A decentralized exchange, or DEX, is generally for the crypto native. Why? Because they exclusively trade in crypto assets, and hence don’t allow you to exchange between your fiat (cash) and cryptocurrencies. As such, cryptocurrencies are absolutely necessary to use DEXs. Hence, at least for the time being, centralized exchanges, or CEXs, are still an important part of getting funds inside the crypto ecosystem.

Decentralized exchanges use a set of smart contracts to set up the prices of different cryptocurrencies against each other through algorithms. This is in direct opposition to brokers who run managed ‘order books’ instead.

Liquidity pools are funded by platform users termed as Liquidity Providers (LP). The pools are then used to facilitate trades and portions of the trading fees are redirected to the liquidity providers as rewards in exchange for both providing liquidity and bearing the risks that come along with it.

Transactions on a DEX are directly recorded on the underlying blockchain meaning that anyone who wishes to do so can check and confirm trades. Most of the DEXs are built with open source code and blockchain developers can utilize existing code to generate new and better projects. For example, Uniswap has various popular spin offs through this exact same mechanism, such as PancakeSwap, QuickSwap, and SushiSwap.

What are the pros and cons of DEXs?

Pros of decentralized exchanges:

  • You can maintain a higher level of anonymity as there is no KYC (Know Your Customer) or AML (Anti-Money Laundering) needed.
  • As you maintain control of your funds the whole time, there is no counterparty risk.
  • You can enjoy access to unlisted tokens before they are added to CEXs. This means that you can enjoy purchasing those tokens at a lower price before it increases once they get listed on CEXs.
  • It has especially strong utility in developing countries that lack proper banking and financial services.

Cons of decentralized exchanges:

  • DEXs are often not as user-friendly or easy to use as CEXs.
  • As they are not regulated, they have fewer fail-safes. This increases the risk of lost funds for users.
  • DEXs generally have lower trading volumes and liquidity than CEXs, leading to a larger gap between the bid and ask prices.
  • Vulnerabilities in the smart contracts can easily lead to loss of funds through protocol hacks.
  • It’s easier to get scammed or ‘rug-pulled’ due to access to unvetted coins on DEXs.

How can you use a DEX?

A majority of today’s decentralized exchanges need you to connect with them through a hot cryptocurrency wallet, such as MetaMask, or a cold wallet, such as Trezor. Generally, you should be able to access a DEX through its official website on a desktop browser. The official website usually has a ‘Connect to a wallet’ or ‘Enter the app’ button

Generally, a decentralized exchange’s official website has a ‘Connect to a wallet’ or ‘Enter the app’ button which you can click on a desktop browser to access the DEX. When you connect your wallet, you also need to keep in mind that you own enough cryptocurrency of whichever blockchain you’ll be interacting with. For example, ETH for Ethereum, MATIC for Polygon, BNB for BNB Smart Chain, and so on. This is so that you are able to pay for the transaction fees, better known as gas. Once you connect your wallet and have enough funds, you can conduct swaps between any crypto asset that you have and token that the DEX offers.

How much are the fees for using DEXs?

While fees differ depending on the DEX, they usually range from 0.3% to 0.5%. The fees are then split between liquidity providers and the protocol. The other main fee in a DEX is the gas fee. In Ethereum’s situation, the gas fees can often be much larger than the swap fees charged by the decentralized exchange. Fortunately, a coordinated effort has been made to create cross-chain bridges between various blockchain networks. In fact, a lot of popular DEXs now offer multi-chain support which gives crypto trades multiple options of what networks to conduct trades on. This includes both layer 1 networks, such as Avalanche and BNB Smart Chain, as well as Ethereum layer 2 solutions, such as Arbitrum and Polygon.

IMPORTANT INFORMATION

This material is intended to be of general interest only and should not be construed as individual investment advice or a recommendation or solicitation to buy, sell or hold any security or to adopt any investment strategy. It does not constitute legal or tax advice. The views expressed are those of the author and the comments, opinions and analyses are rendered as of the publication date and may change without notice. There is no guarantee that any forecasts or predictions made will come to pass. The information provided in this material is not intended as a complete analysis of all material facts or circumstances regarding any country, region or market. All investments involve risks, including possible loss of principal.

Risk management does not imply elimination of risks, and not all investments are suitable for all investors. The information and opinions contained in this material are derived from proprietary and non-proprietary sources deemed by MANTRA to be reliable, are not necessarily all inclusive and are not guaranteed as to accuracy. Data from third party sources has not independently verified, validated or audited. MANTRA accepts no liability whatsoever for any loss arising from use of this information; reliance upon the comments, opinions and analyses in the material is at the sole discretion of the user.

Any products, services and information in this material may not be available in all jurisdictions and are offered local laws and regulation permit. Please consult your own financial professional or legal advisor for further information on availability of products and services in your jurisdiction. Please also see the disclaimer which is found at the bottom of this website under the heading “Important Disclosures”.​

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