Introduction
Since Bitcoin was launched in 2009, cryptocurrency trading has significantly increased in popularity more than ever. During its rise, centralized exchanges were the only platforms available for use as to why it has dominated the scene. However, as the landscape continuously evolved, decentralized exchanges or better known as DEXs were introduced, offered more ways to trade crypto assets, and proceeded to become the major player.
Furthermore, DEXs have gained more popularity within the growing DeFi space through offering numerous advantages which we will further explore in this guide. But first, let's explore how decentralized exchanges started, their connection to DeFi, and what's to expect from them in the long run.
What Are Decentralized Exchanges (DEXs)?
A decentralized exchange is a platform that allows crypto users to trade their crypto holdings directly with each other which is far different from a centralized exchange where trading needs a middleman or a central financial authority. Thus, instead of relying on third parties, including banks or exchange platforms, DEXs solely operate within the blockchain technology and the use of smart contracts which enables automation of all transactions in the most secure and trustless manner.
In contrast with centralized exchanges, DEXs highlights automated trading in which they use systems like automated market makers or AMMs or liquidity pools to initiate trades. For that very feature, users are now given the full control of their funds as well as their private keys which also means that they're also responsible for their security. Also, as mentioned, there's no central authority involved in every transaction which also pertains to its immunity to censorship and shutdowns.
DEXs in DeFi Ecosystem
DeFi is continuously evolving as a movement of looking for new ways in recreating the financial services like loans, saving, and trading, all within the blockchain network - without the banks. Thus, DEXs, indeed plays a major role in the decentralized finance space as significant contributors in establishing many of its core features which are the following:
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Liquidity Provision - Users can earn rewards when they contribute to the liquidity of DEX pools which are elements that's mainly used to facilitate trades.
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Token Swapping - These exchanges enable participants to initiate swapping of tokens or cryptos directly without undergoing KYC verification, eliminating the hassle of providing additional personal information and documents.
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Yield Farming and Staking - Most DEXs also provide opportunities for users to acquire and generate passive income through several methods such as yield farming and staking. This is one of the reasons why decentralized exchanges are gaining popularity over centralized ones.
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Cross-Chain Trading - And now, most DEXs are integrating a new system of cross-chain capabilities that allows tokens to move from one blockchain to another.
Why Are DEXs Growing So Quickly?
As mentioned, DEXs are emerging as the major player in the DeFi ecosystem and there are several factors that contribute to its rapid growth. Here are the following:
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DeFi Boom - The development of DeFi applications has also resulted in the adoption of DEXs. wWhereas, DeFi platforms are mostly reliant on DEXs for several essential financial activities like trading, liquidity, and other services.
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Security and Privacy - Among the key advantages of DEXs compared to CEXs is it offers better security. And that's one reason why it gained traction in a small period of time. Aside from allowing users full control over their funds, it also reduced the risks of hacking and mismanagement. Additionally, it promotes greater privacy as it highlights anonymity where users don't need to provide personal information when trading.
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Smart Contracts Adoption - As platforms like Ethereum and Binance Smart Chain emerged, it also made it easier for developers to build DEXs using smart contracts. As a result, it introduced the automation of processes in buying and selling cryptocurrencies which further expanded its growth.
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Community Ownership - Many DEXs are governed by their communities, this particularly means that token holders are given the right to vote in any plans and progress of changes in the platform. This further gives users a sense of purpose by allowing them to have a voice in every development stages of the exchange.
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Global Access - Unlike CEXs that typically implements restrictions and regulations, DEXs allows anyone with a reliable internet connection to access financial services, regardless of wherever they are. Thus, it caters to a broad range of users, even the ones without access to traditional banking which further increases their popularity resulting in rapid growth globally.
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Improved Technology - As mentioned, DEXs have been integrating cross-chain solutions and along with that they also added Layer 2 technologies which further enhanced scalability, lowered transaction fees, resulting in a better user-experience.
Pros and Cons of Using DEXs
Similar to other financial tools, nothing is ever made perfect, while it always highlights advantages it also comes with challenges and DEXs are no exception to that. Thus, here are the key benefits and drawbacks to be considered when weighing if this exchange would suit your preference and financial goals:
Pros:
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As previously discussed, users are given the full authority over their assets and private keys which reduces the risk of loss or theft.
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DEXs are less vulnerable to hacking possibilities, meaning it's more secure than centralized exchanges whereas when the platform is hacked, all user's funds can get stolen. But with DEXs, all assets will remain on the user's wallet. To better understand how to protect yourself in this environment, you might want to read our guide on trading safely in DeFi exchanges.
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Since these exchanges are decentralized, there's no one in power or a central authority that in any way can shut down or limit users from accessing financial services within the platform.
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The use of DEXs technically means eliminating the need for middleman or third parties, resulting in cutting down costs.
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All transactions in a decentralized exchange will be automatically recorded in the blockchain, that's viewable by anyone but can't be in any way altered nor manipulated. This offers participants transparency and ability to review all transaction's accuracy.
Cons:
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Many DEXs platforms, most especially the ones that are built off the Ethereum ecosystem, experience high transaction fees and slow processing times which causes scalability issues.
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Compared to centralized exchanges, DEXs often encounter problems when it comes to liquidity, specifically in large trades.
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DEXs typically have complex interfaces which are not beginner-friendly. In addition to that, users may need to acquire knowledge about crypto wallets and numerous unfamiliar terms that can complicate their navigation experience. To better understand these changes, you might want to read about How DeFi is Changing Traditional Financial Systems.
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Since these exchanges are decentralized in nature, there are concerns about its regulations. This causes uncertainty to users.
Conclusion
Undoubtedly, decentralized exchanges are really changing the methods people engage with crypto trading in the most secure, transparent, and user-controlled way possible. But, it's not without drawbacks that should be considered. Furthermore, for those who don't mind the risks and have their way of eliminating it, DEXs surely offers a promising future in the world of DeFi and cryptocurrencies.
