The blockchain world creates a decentralized, liberating financial space that allows anonymity and minimizes trackability by protecting personal data. Well, isn’t this also apply to the next generation financial world stock market platforms?
DEXs, or decentralized exchanges, are platforms developed using this innovative vision of Blockchain that allow users to buy and sell without any middleman or information center. Unlike CEXs, which model on traditional exchange platforms and require users to authenticate and have custody over private keys, only peer-to-peer transactions are possible with DEXs. A number of smart contracts are processed on decentralized exchanges to facilitate and secure peer-to-peer trading.
Too complicated?
KEY TAKEAWAYS
- With its peer-to-peer financial technology, decentralized exchanges, which enable users to make new generation borrowing, lending, selling, and purchasing transactions, are platforms where almost all cryptocurrencies can be transacted.
- There are three types of DEX, which can be listed as on-chain order books, off-chain order books, and autonomous market makers.
- DEXs are advantageous in terms that they allow you to take full control of your funds, require no credentials, and have low transaction fees. It is also compatible with DeFi objects as they allow peer-to-peer trading.
- However, factors such as security vulnerabilities and slow transaction speed cause DeFi to bring some disadvantages.
I have prepared a very comprehensive DEX review content for you. Here you will find the working principles of DEXs, their advantages and risks, different DEX platform types, and other details.
Table of Contents
Decentralized Exchange Definition – Closer Look
With their peer-to-peer financial technology, decentralized exchanges, which enable users to make new generation borrowing, lending, selling, and purchasing transactions, are platforms where almost all cryptocurrencies can be transacted. Many small-cap and incipient cryptocurrencies that are not yet listed on centralized exchanges can be traded on DEX platforms. Buying the tokens of these projects, which are in their infancy period, is one of the favorite practices of investors to earn long-term profits.
A decentralized exchange has almost the same functionality as a centralized traditional exchange. However, since the transactions take place directly between the buyer and the seller, not with the intermediation of specific central authority, these platforms are often called “P2P exchanges”. As they support multiple cryptocurrencies and create big, global, and easy-to-enter marketplaces, these platforms are also very suitable for using DeFi products such as yield farming, borrowing, lending, liquidity mining, etc.
All transactions made in DEXs are built by smart contracts for security and transaction sustainability, while these smart contracts can be integrated into financial products and services on different Blockchain networks.
How Do Decentralized Exchanges Work?
To understand how Decentralized Exchanges work, it may make sense to first classify them into three basic categories:
- On-chain order books
- Off-chain order books
- Automated Market Makers (AMM)
Let’s start reviewing each of them!
On-Chain Order Books (StellarTerm, BitShares, Ethex)
This type of DEX has network nodes functioning to keep track of all transactions that take place. They record orders created by users. In order for the peer-to-peer transaction to work without any central control, each miner in the system must approve the transaction. Just like the logic that creates Blockchain chain technology.
- On-chain order books do not require any relayer or server to work. This can make wallet-to-wallet trading much more cost-effective.
- On-chain order book DEXs are more durable when it comes to manipulation. Because in this type of DEX, the offers for the assets are published on each node forming the chain. This ensures transparency by preventing exchange users from making exclusive or private deals.
- On-chain DEX allows very fast and efficient processing of orders. You do not need to make a deposit before trading. When you want to make a transaction, you can complete the purchase directly from your wallet.
- Frivolous offers that keep the stock market busy and manipulate peer-to-peer trading may be far less common in on-chain order books. Because it usually requires paying to make an offer on such platforms. This payout means gas traders think twice before making an offer.
Off-Chain Order Books (Binance DEX, 0x, IDEX, dydX)
The main feature that distinguishes Off-Chain Order Books from others is that all transaction records on the platform are kept in a central entity located outside the chain. Due to these features, such DEXs can also be called “semi-centralized” exchanges in the market. The main reason for the launch of the platforms is that users can experience the advantage of both decentralized trading and options in the traditional trading world at the same time.
Off-Chain order books, like other DEXs, allow transactions to take place on a peer-to-peer basis. There are price, volume, expiry date, and order type details of the transaction in each order book. When the user adds any transaction order to the order book, it is checked whether there is an available fund via smart contract and the transaction is executed if the necessary conditions are met.
The working principle of off-chain order books is not to use the main Blockchain chain for the validation of every transaction. Instead, the center where information is recorded is located off-chain, helping to reduce costs and open up an extra privacy space for users.
The main advantages of off-chain DEX order books are as follows:
- Users can make transactions by paying a lower gas fee.
- Orders can be processed more quickly.
- When storing your funds, you do not have to entrust them to any platform. The control of your private keys belongs only to you.
Automated Market Makers (AMM) (Uniswap, Balancer, Curve)
Consider a decentralized exchange platform that uses a special mathematical formula to price its own assets. They set prices through an agreed algorithm, rather than determining the values of assets through order books found on traditional exchanges. The formulas used may vary according to the protocols used. This working system constitutes the basic logic of automated market makers.
Popular automated market makers such as Uniswap and Pankeswap determine the value of assets with algorithms created by various variables such as the number of coins in the liquidity pool, instead of setting prices through order books. These algorithms, which are basically based on the fact that the total liquidity of the pool remains the same, make the price volatile in order to ensure equality.,
Understanding How Automated Market Makers Work
Imagine the working logic of Automated Market Makers like this:
No Need for Counterparts
On traditional exchanges, you need another trader to determine the value of a particular pair. Because the order book, which is filled with the orders of the traders, determines the market value of an asset. This situation is not much different in Automated Market Makers. Because here, too, you are trading on parities. But this time, you don’t need another trader to set the price of an asset. The smart contract on the platform creates the market for you and determines the asset value.
Not Peer-to-Peer, But Peer-to-Contract
While we were talking about off-chain and on-chain order books, we especially focused on the concepts of wallet-to-wallet or peer-to-peer trading. Because on these platforms, users were making purchases and sales directly with their own assets, in direct communication with each other. In AMMs, on the other hand, the situation is defined as peer-to-contract. Because there is no need for other users who create orders, an order book, or an order type. There is a system that only clarifies the price of the asset you want to buy according to the formula determined in the smart contract. In the absence of a counterpart, liquidity providers in smart contracts are used to create the market.
What is the role of liquidity providers?
Although there is no need for order books, AMMs need the liquidity providers of smart contracts. Because if a pool is not adequately funded, slippages will be high, making the platform unreliable for trading. What AMMs do to reduce sillage rates is to encourage investors to invest their assets in liquidity pools. In this way, when users trade, they trade against funds that are available here and support the functionality of the platform.
So, what is the benefit of liquidity providers from this situation?
In order to encourage liquidity investment, AMMs offer varying rates of rewards to liquidity providers. Providers rewarded with a certain commission for each transaction performed in the pool earn LP tokens. The LP token can be used as long as the relevant provider wishes to stay in the pool. When a provider with tokens wants to exit, it sells its tokens and leaves the system by taking its share of the transaction fees.
This advanced system, which is based on the investments of individual liquidity providers, thus provides a more reliable trading area.
Advantages of Using DEXs (Decentralized Exchanges)
There are a number of advantages that cause even traders who usually prefer to use CEXs to switch their course to DEXs. The first, of course, is the willingness to buy projects in their infancy at floor prices, which can’t even be found on the most popular CEXs. DEX removes limits by allowing you to trade almost any cryptocurrency.
Here are other advantages of using DEX:
| Custody of your money belongs to you. | Once you have a traditional exchange account, you open one and transfer your funds to your wallet or account of which custody is on the exchange. With DEXs, you don’t need to do this. You can trade directly connected to the wallet-to-wallet system. Transact through your wallet with one click. No need to entrust your money to a central area. |
| You are in control of your private keys. | Depending on the first advantage, you will be able to use non-custodial hot wallet options, since you will not be using the wallets of centralized exchange platforms. This means that you have full control of your private keys and funds. You won’t be harmed in a corporate hacking scandal either, as the funds are not stored in a centralized location. |
| Minimum transaction fees. | The expenses required to establish a centralized system in traditional exchanges, implement the necessary privacy and security protocols in this system, and maintain regular regulations are not required in DEXs. This means a transaction model that can operate at much less cost and where user devices become servers. Maximum efficiency, and minimum transaction fees on the blockchain. |
| Extended privacy. | Within the scope of Know Your Customer (KYC) policies in centralized exchanges, you may be asked for your selfie, your identity information, and even your residence information. In DEX, there is no such registration process. You can only trade with your wallet ID without having to share any of your information. |
| Lots of options. | DEX platforms like Uniswap are a true paradise for token pairs, enabling the buying and selling of almost any cryptocurrency in circulation. On such platforms, you can now mint a coin in the relevant ecosystem and start swapping with the token minted by another friend. Lots of options, real financial freedom. |
Disadvantages or Risks of DEXs (Decentralized Exchanges)
Of course, security sensitivities are the risk factor that traders who stay away from DEX talk about the most. Here are the main disadvantages or risks of using decentralized exchanges:
| Low processing speed | The basic logic of the peer-to-peer system requires that information be spread to the entire network and that each miner in the system approves this transaction in order for each transaction to take place. Although this situation strengthens system security, it can slow down the processing speed of transactions. This processing time after the creation of orders can cause slippage in the determined transaction price and cause losses for the traders. |
| Front-running | Front-running, which is associated with low transaction speed, examines publicly published order-books and creates orders with a higher gas fee to take place before these transactions. This situation, which changes the market balance, may cause losses for users who make strategic moves before others due to the slowness of the transaction speed. |
| Liquidity problems | Exchanges need sufficiently rich liquidity pools to function smoothly. However, DEXs that can create pools based on their individual liquidity investments constantly have problems with this. Liquidity varies according to the number of active users on these platforms. This may disrupt the processing of orders. DeFi seems to find a solution to this disadvantage of DEX with its new technologies that can solve the liquidity problem. |
| Ethereum-based options | Did you know that the majority of active DEXs today are built on the Ethereum blockchain? This means that the coins available in these DEXs may also be Ethereum-based coins only. This is a major drawback: Users will not be able to buy and sell coins outside the blockchain where the DEX they are using is located. |
| No customer service | The centralized exchanges’ approach to customer satisfaction is absent from DEXs. Because we can’t talk about any actor that aims to make a profit in DEXs. This means that there is no customer service system to solve your problems or guide you constantly. You are solely responsible for the asset management process. |
How to Earn on DEXs: Staking & Farming, Liquidity Pool, Lending
DEXs usually offer three different options to users who want to earn passive income: you can stake your money, you can yield farming, or you can earn rewards in proportion to the pool volume you open as a liquidity provider. We briefly mentioned the last one above, but under this heading, we will have the opportunity to examine all three in detail.
Staking & Farming
To clarify what is staking provided by DEX, first, let’s see what is staking and proof-of-stake as prominent concepts.
Staking means you lock the coins you own into a specific smart contract. This locking process allows you to earn more coins based on the number of coins you have locked and the time you have committed.
| DEX platforms allow users to stake a certain coin, giving them specific rewards. This process is called yield farming. Cryptocurrency holders have the chance to earn passive income when they stake their assets by choosing one of the specified duration options. This creates a revenue model that is very similar to the proof-of-stake mechanism maintained to ensure the security of cryptocurrencies. |
So, how does the staking logic work in DEXs? The reliability of any Blockchain infrastructure and the consistency of chains are based on the logic of Proof-of-Stake. Proof-of-Stake, on the other hand, works by users staking their own assets via smart contracts. This system, which checks the immutability of each block within the framework of the determined consensus mechanisms, prevents the transactions of network fraudsters with effective validators.
The Proof-of-Stake mechanism provided by smart contracts and staked coins provides two benefits for the cryptocurrencies:
- A blockchain-powered by smart contracts
- Increased liquidity through funding
Uniswap / LTO Network Liquidity & Staking Program
Want to hear about a popular staking / yield farming campaign? For example, the staking farm liquidity program offered by Uniswap in partnership with LTO Network aims to distribute a total of 500,000 LTO to stakers. This program, which will be generated by distributing 0.19 LTO for each block, will start in block 11321000 on the Ethereum network. Users who stake their coins will automatically start farming their rewards when 11321000 blocks are mined. Moreover, this process will proceed without minting new coins. This means that every time a block is mined, no new coins will be minted, meaning the total LTO supply will not increase (meaning that the risk of falling coin values will decrease). Each coin will be distributed to users from the ready liquidity wallet.
Pancakeswap Staking Farms
Like many other DEXs, Pancakeswap is one of the platforms that offer staking farms for many parities. When you enter the Farms page of the platform, you will see that you can yield farming for many cryptocurrencies such as CAKE – BNB, BUSD – BNB, PORTO – BNB. When users choose, for example, CAKE – BNB farming, they stake CAKE at the set rate for a certain period of time. They receive BNB rewards according to the number of coins they stake and the staking time.
Pools / Becoming Liquidity Provider
The liquidity that enables decentralized exchanges to continue to serve comes from users who want to collect rewards by contributing to liquidity pools. Users consist of ordinary DeFi users and they earn income from swaps by providing liquidity to the smart contract controlling the platform’s pool. The income to be obtained by each liquidity provider may vary according to the liquidity it provides and the related smart contract conditions. In short, the more liquidity you provide, the more income you will earn per swap.
Lending
On DEX platforms that support peer-to-peer decentralized financial transactions, you can lend to users individually and earn passive income over the interest rate. The real owners of the money are now taking the place of the banks, which took almost the entire share of the pie in the traditional banking system.
Lending platforms encourage users to lock their assets into smart contracts and pay them a certain amount of APY for this lock (these APYs can be much higher on decentralized platforms compared to CEXs). The loan given to the Borrower is returned to the lender together with the APY income at the end of the maturity period. The entire lending and borrowing process is carried out through smart contracts. This eliminates the risk of not getting the debt back.
You can use the assets you own for DeFi transactions via DEXs and earn passive income in this way.
What is CertiK Blockchain Security and How Does It Relate to DEXs?
Numerous security scandals implicating DEXs are leading people to ask the question “okay, let’s use DEX, but which one?”. The answer to this question is given by the results of certificates and audits in the modern Blockchain world. Certik is an initiative that audits blockchain initiatives for their security features, scores them, and produces various solutions to their vulnerabilities. While trying to choose between DEXs and trying to understand the pros and cons of different platforms in terms of security, it might make sense to first take a look at Certik scores.
How to Use Certik to Review Your Fav DEX?
You can take a look at the detailed review on Certik to understand how your favorite DEX performs in terms of security, to discover how it has pros and cons in terms of;
- Static analysis,
- Governance & autonomy,
- Market volatility,
- Safety assessment,
- On-chain monitoring,
- Social sentiment.
For this, take the following steps:
- Go to Certik Security Leaderboard.
- On the main page, you will see the security score-based ranking of 30 leading projects. If the DEX platform you want to review is among these, click on its name. If not among these, enter the project name in the “Search your project by name / token name” field.
| CertiK not only tells you which DEX you should choose but also provides you with audit services for Ethereum-based Blockchain solutions and projects that you develop. Moreover, you can prove your reliability to your followers by sharing the score you get from this audit service on your website and social media channels. Remember, community perception is everything in the cryptocurrency world. |
- The system will present you with the page with the score and detailed review. Check it out and make your decision.
10 Most Popular Decentralized Exchanges (DEXs)
| DEX | Features |
|---|---|
| dYdX | The most important feature that distinguishes dYdX from other DEXs is that it allows margin and perpetual trading. Users can trade full 100x leverage by taking advantage of the decentralized network. Moreover, for most of the transactions, users are not even charged a gas fee. Users can earn advantageous APY rates by depositing their stablecoins or other alternatives. While borrowing stablecoins can earn holders 10%, you can earn 5% by depositing. One disadvantage is that margin trading pairs are limited to three. |
| UniSwap | Uniswap’s favorite feature is the swap function. Users can swap any two Ethereum assets in ERC-20 standards very easily. The liquidity pool service is great for those who want to earn passive income with crypto. Moreover, while UNI serves as a crypto asset to support developers within the ecosystem, the platform promises potential. Note also that Uniswap supports 5 different wallets. |
| PancakeSwap | Standing out with its eponymous swap function, PancekeSwap allows easy swapping at very affordable prices. Moreover, you can avoid surprises by specifying the slippage rate you prefer during the process. Syrup pools allow you to profit from staking on the platform. You can stake CAKE, the native token of the platform, and earn great APY rates. Moreover, as an extra advantage, this DEX provides the advantage of generating income from lottery and prediction. |
| Kine Protocol | Kine Protocol, which allows leveraged cross margin trading and zero slippage, is also an NFT marketplace. Users can buy and sell by accessing all NFTs on the Binance Smart Chain, Ethereum, Polygon, and Avalanche network via Kine Protocol. Moreover, DeFi enables derivate trading, and staking. Remember, Kine Protocol supports exactly four different chains to avoid chain limitation which is a major problem with DEXs. Therefore, it gives you access to all of the tokens in these chains. |
| ApolloX DeX | Imagine ApolloX as a hybrid exchange. Because when you enter the website, you can easily choose where you want to trade from a small box in the upper left corner. The most important feature of the platform is that it offers a special function called the NFT lottery game. From here, you can earn a significant income with a method similar to gambling. Allowing you to trade leveraged up to 100x, ApolloX also offers additional tools for your strategy creation. |
| SpookySwap | Working with Fantom Opera infrastructure, Spooky Swap draws attention with its high transaction volume and allows the chain to chain transactions. Users can choose SpookySwap for trading between Cronos, BSC, OEX, Polygon, Fantom, Arbitrum, Avalanche and Harmony networks. Moreover, this platform is a good option not only for cryptocurrencies but also for NFT trading. With Farming, users can earn APR over 40%. |
| HoneySwap | HoneySwap, which aims to perform a swap transaction every three seconds and charges only $ 0.001 per transaction, also serves as a cross-chain bridge. Users can access the xDAI network to yield farming or participate in liquidity pools. The platform offers zero gas fees and instant transaction confirmation to users who buy xDAI with fiat money. |
| SushiSwap | Get to know Sushiswap with liquidity higher than 2B Dollars: a real swap heaven that allows you to trade with 2.7K pairs. Users can make peer-to-peer lending and borrowing. One downside: Like every AMM on the Ethereum network, Sushiswap charges very high gas fees. |
| QuickSwap | QuickSwap, a layer-2 DEX that provides passive crypto income with options such as pool and farm, provides bridge functionality with Matic PoS, Relay and SOL. Users only pay a fee of 0.3% to transact, and active participation earns users QUICK, the platform’s governance token. The fact that the platform is a layer-2 DEX enables very fast transactions and very low gas fees. |
What is the best decentralized exchange in terms of trading volume?
When ranked by trading volume, the best decentralized exchanges can be ranked as follows: Uniswap (v3), Pancakeswap (v2), Uniswap (v2), Trader Joe, Sushiswap, Compound Finance, Raydium, Spookyswap.
How to develop a decentralized crypto exchange like Uniswap?
In order to produce your own DEX, you need to have the infrastructure that can support a certain transaction speed, and be ready to support the platform with a significant amount of liquidity. To start coding, you need three basic things:
Factory contract: This contract is the protocol that enables the creation of an LP token for each swap transaction for pairs.
Routing contract: This contract allows users to interact with the factory contract through the platform.
Front-end code: It creates the interface that allows users to interact with the platform.
What is the largest decentralized exchange?
Uniswap is the largest DEX platform in terms of market size and is hosted on the Ethereum Blockchain.
Why do crypto users prefer DEXs?
Many users prefer decentralized exchanges because they want their personal information and transaction processes to be truly autonomous. Therefore, it is possible to say that the most common answer to this question is “because of the degree of decentralization”.
What are types of decentralized exchange?
There are three types of DEX. These can be listed as on-chain order books, off-chain order books, and autonomous market makers.
