How Do Decentralized Exchanges Work?
When it comes to crypto trading, using the proper crypto exchange that suits your needs is imperative. And even though crypto exchanges are almost similar in nature, there are distinct differences between the two types of crypto exchanges—centralized and decentralized. The two differ in infrastructure, services provided, and underlying protocols. Nonetheless, choosing between a centralized exchange (CEX) or a decentralized exchange (DEX) lies on how you want to trade or what kinds of benefits you want to harness from trading from one of them.
More so, in this article, we will discuss how decentralized exchanges (DEXs) work.
Decentralized Exchanges (DEX)
Today, we can see multiple generations of decentralized applications like decentralized crypto exchanges in the market. A decentralized exchange is a P2P (peer-to-peer) marketplace where users can trade their assets in a non-custodial manner; hence, without an intermediary to facilitate the transactions. Instead, decentralized exchanges use blockchain-based smart contracts when executing transactions.
These ‘permissionless’ transactions have catapulted decentralized exchanges’ growth and popularity among traders in the crypto space.
How Does A DEX Work?
The design and infrastructure of each decentralized exchange vary; each offers differing benefits in trade-offs, feature sets, scalability, and decentralization of the platform. Most of the time, decentralized exchanges use two types of protocols: either an order book or automated market makers.
Order Book DEXs
An order book is a real-time collection of open buy and sell orders in the market. In fact, this is the foundational pillar of electronic exchanges. An order book allows an exchange to match buy and sell orders in its internal system.
It is mandatory that an order book records every transaction that is posted on the blockchain. In turn, this requires higher throughput when it comes to network security and decentralization. Even so, Order Book DEXs have become feasible and attractive to traders, especially with the release of hybrid order book DEXs after on-chain order book DEXs.
Samples of popular order book DEXs: 0x, dYdX, Loopring DEX, and Serum.
Automated Market Makers (AMMs)
Automated Market Makers (AMMs), in simple terms, are like money robots that easily quote prices between two or more assets. AMM does not use Order Books, instead, it utilizes a liquidity pool wherein users can swap their tokens against each other, with the price being determined by an algorithm that is based on the proportion of tokens in the said pool.
AMMs enable instant access to liquidity in markets, and liquidity providers, and even allow traders to earn passive income through trading fees.
Samples of popular Automated Market Makers DEXs: Bancor, Balancer, Curve, PancakeSwap, Sushiswap, Trader Joe, and Uniswap.
Conclusion
In hindsight, decentralized exchanges allow traders to harness the benefits of crypto trading in an innovative, secure, and permissionless manner—which can be beneficial as it does not require intermediaries.
Since its introduction to the public, DEXs remain a go-to marketplace for new and experienced traders, who will support the long-term growth and immense adoption of crypto trading.
If you want to partake in this massive movement, you can use our ecosystem at Blockchain Commodities—Hippo Wallet, Riverex, and RiverPay—your keys to a decentralized world.