Decentralized exchanges, or DEXs, are peer-to-peer markets where cryptocurrency traders can conduct transactions without giving up control of their funds to a custodian or intermediary. These transactions are made possible by the use of smart contracts, which are self-executing contracts that are written in computer code.
The purpose of DEXs was to do away with the need for any authority to monitor and approve trades made inside a particular exchange. Peer-to-peer (P2P) trading of cryptocurrencies is possible through decentralized exchanges. A marketplace that connects cryptocurrency buyers and sellers is referred to as peer-to-peer. They are often non-custodial, meaning users retain ownership of the private keys to their wallet. Users can access their cryptocurrency thanks to a private key, a sort of high-tech encryption. After logging into the DEX with their private key, users can immediately access their cryptocurrency balances. They won’t be needed to provide any personal information, such as names and addresses, which is fantastic for those who value their privacy.
Automated market makers, among other innovations that addressed liquidity-related issues, helped draw people to the decentralized finance (DeFi) field and significantly aided in its expansion. By optimizing token values, swap fees, and slippage while providing a better rate for users, DEX aggregators and wallet extensions fuelled the expansion of decentralized platforms.
How do decentralized exchanges work
Smart contracts are used by decentralized exchanges to enable direct order execution by traders. Centralized exchanges, on the other hand, are run by a centralized institution, such a bank, which is also engaged in the financial services industry and seeks to turn a profit.
Because they are regulated organizations that guard users’ money and provide beginner-friendly platforms, centralized exchanges account for the vast bulk of trading volume in the bitcoin market. Even deposit insurance is offered by some centralized exchanges.
One might compare the services provided by a centralized exchange to those provided by banks. The bank protects its customers’ money and offers security and monitoring services that people cannot supply on their own, facilitating the movement of money.
Decentralized exchanges, on the other hand, give customers the option to trade directly from their wallets by engaging with the smart contracts that power the trading platform. If a trader makes a mistake, such as losing their private keys or sending money to the wrong addresses, they are accountable for losing that money.
Decentralized exchange portals issue a “I owe you” (IOU) on behalf of the customers’ deposited monies or assets, which can then be freely traded on the network. IOUs are simply tokens built on the blockchain with the same value as the underlying item.
On top of well-known blockchains that support smart contracts, a number of well-known decentralized exchanges have been created. They are constructed directly on the blockchain since layer-one protocols serve as the foundation for them. The Ethereum blockchain is used to power the majority of DEXs.
Using decentralized exchanges: best practices
There is no registration required to use a decentralized exchange because you can communicate with these platforms without even providing an email address. Instead, traders will require a wallet that works with the smart contracts on the network of the exchange. DEXs’ financial services are available to everyone with a smartphone and an internet connection.
The first step in using DEXs is choosing the network one wishes to utilize because there are transaction fees associated with every trade. The next step is to select a wallet that works with the chosen network and fund it using the native token of that wallet. The token used to cover transaction costs in a particular network is called a native token.
It is simple to communicate with decentralized applications (DApps), such as DEXs, when users have wallet extensions that enable direct access to their cash in their browsers. These must either be imported into an existing wallet using a seed phrase or private key, or a new wallet must be created, and installation is the same as for other extensions. Password protection helps to further enforce security.
Due to the built-in browsers and readiness to communicate with smart contract networks, these wallets may also include mobile applications so traders can use DeFi protocols while on the road. Users can import their wallets from one device to another, synchronizing them between them.
Selecting a wallet is the first step; the next is to fund it with the tokens required to cover the network’s transaction fees. These tokens must be purchased on controlled exchanges and may be quickly identified thanks to the ticker symbol they employ, such as ETH for Ethereum. Users just need to withdraw their tokens to wallets under their control after purchasing them.
It is essential to avoid sending money to the incorrect network. Users must withdraw their money from the proper account as a result. Users can connect their wallets using a pop-up prompt or by clicking the “Connect Wallet” button in one of the top corners of DEXs’ websites if they have funded their wallets.