Decentralized Exchanges

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Decentralized Exchanges Overview

What do we mean by Decentralized Exchanges?

A decentralized exchange (DEX) is a platform that enables users to trade cryptocurrencies directly with one another without the need for an intermediary, such as a centralized exchange. DEXs operate using smart contracts, which are self-executing contracts with the terms of the agreement directly written into code.

DEXs offer increased security and control over funds, while centralized exchanges are typically easier for beginners and offer faster trading. The choice between the two often depends on the user's specific needs and level of comfort with managing their own cryptocurrencies.

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Frequently asked questions

Centralized exchanges, like Binance or Coinbase, function as intermediaries where users sign up, deposit funds, and perform transactions. These exchanges hold users' funds and facilitate trades within their own databases. While they offer ease of use, they can be prone to security risks and may restrict users' access to their assets.

In contrast, DEXs allow users to retain control over their funds by never taking custody of their coins.

DEX facilitate trades in one of three ways: an on-chain order book, an off-chain order book, or an automated market maker (AMM) approach.

  1. On-chain order books record every transaction, including purchase requests and order cancellations, directly onto the blockchain. This method offers high transparency and security, but the need to record everything on the blockchain can make it slower and more expensive.
  2. Off-chain order books record only the final transaction on the blockchain, while the rest of the process takes place elsewhere. This method can be faster and less costly than on-chain order books, but it can also present some security risks similar to centralized exchanges.
  3. Automated market makers remove the need for a counterparty to a trade. They use algorithms to set the price and allow users to trade regardless of whether there's someone on the other end of the trade. They typically use "liquidity pools," where users are incentivized to keep some of their funds in a smart contract that can be used for trades. As a result, individual users play a significant role in facilitating trades.