What Is a DEX in Crypto? How Decentralized Exchanges Work | How to buy crypto from Dex
This Article will help you understand decentralized exchanges (DEX) from scratch, step by step. This information will be particularly useful for those who are interested in the world of cryptocurrency. Please read all the steps carefully to enhance your trading journey.
Table of Contents
Introduction of Decentralized Exchanges
When we discuss about cryptocurrency then always get to listen about Dex A decentralized crypto exchange (DEX) is a peer-to-peer digital marketplace where anyone can buy and sell cryptocurrencies.
Decentralised exchanges (DEXS) operate on peer-to-peer blockchains with no intermediaries
What Is a DEX (Decentralized Exchange) in Crypto?
Crypto investors who use self-custody wallets must interact with decentralized applications (dApps). Unlike centralized businesses such as Coinbase, which operate on servers inaccessible to the public, dApps run on distributed networks.
Because dApps are built on decentralized blockchains, they offer complete transparency and high efficiency.
The most popular dApps are found in the decentralized finance (DeFi) sector, primarily on the Ethereum network.
This space includes various applications for staking, lending, derivative trading, and decentralized exchanges.
Decentralized exchanges (DEXS) enable crypto traders to swap coins and tokens without a central authority. Currently, there are no regulations requiring “know your customer” (KYC) processes in crypto, so no paperwork or approval is needed to trade on a DEX.
To understand how a decentralized exchange (DEX) works, we must first grasp how a traditional centralized cryptocurrency exchange functions.
Centralized Crypto Exchange
A centralized crypto exchange (CEX) is a marketplace for cryptocurrencies that is operated by a central organisation, which facilitates the buying and selling of these digital assets.
When you hold cryptocurrency on a CEX, the exchange takes custody of your private keys on your behalf. Private keys are crucial in the crypto world because they are the only means to prove ownership of digital assets.
However, because you don’t have direct access to your private keys when using a CEX, you cannot trace your digital assets on the blockchain to verify that the exchange is holding your crypto in a 1:1 ratio. It’s important to note that exchanges often pool their customers’ cryptocurrencies and may use them for their own purposes.
For example, FTX misused its customers’ crypto for personal gain and subsequently lost a significant amount of it.
Despite the associated risks, most retail crypto traders prefer to hold their assets on a centralized exchange (CEX).
Decentralized Crypto Exchange
To transact on a decentralized exchange (DEX), you need to connect your cryptocurrency private keys using a self-custody wallet, such as the Trust Wallet.
Since centralized exchanges (CEXs) do not grant users access to their private keys, it is impossible to interact with DEXs or any decentralized applications (dApps) through a custodial wallet.
Unlike centralized exchanges (CEXs), decentralized exchanges (DEXs) do not hold your cryptocurrency. When you want to trade on a DEX, you connect your wallet and can disconnect it once you’re done.
Your crypto remains securely stored in a wallet protected by a seed phrase, independent of the exchange.
Centralized vs. Decentralised Crypto Exchanges
To understand how a decentralized exchange (DEX) works, we must first comprehend the functioning of a traditional centralized cryptocurrency exchange.
How Do I Execute a Trade on a Decentralized Exchange (DEX)?
- To place a crypto trade on a DEX, follow the steps below.
- Find a DEX that supports the crypto assets you wish to trade.Â
- Fund your self-custody crypto wallet with crypto.Â
- Connect your crypto wallet to a DEX that supports the coins/tokens you wish to trade.
- Choose the cryptocurrency pair that you wish to buy/sell.
- Select the gas fee you are willing to pay (the wallet will approximate this for you).
- Wait for your trade to be confirmed (For the Ethereum network, this takes a few minutes).
Automated Market Makers (AMM)
You may have wondered how trades are actually filled on decentralized exchanges (DEXs) without a central intermediary or traditional market makers involved.
DEXs operate using automated market makers (AMMs). AMMs are smart contracts (algorithms) that automate the process of buying and selling digital assets.
In contrast, traditional exchanges rely on market makers, who are finance professionals who provide liquidity by buying and selling assets through an order book.
Liquidity Pools
On decentralized exchanges (DEXs), the traditional order book is replaced by liquidity pools. Liquidity pools consist of cryptocurrency that is locked in a smart contract.
Anyone can become a market maker in decentralized finance (DeFi) and earn fees by contributing an equal value of two or more cryptocurrencies to a liquidity pool.
For example, if you own $1,000 worth of Ether (ETH) and $1,000 worth of USD Coin (USDC), you can contribute both of these cryptocurrencies to an ETH/USDC liquidity pool on any DEX you choose.
In return, you will receive a liquidity provider token that represents your contribution. You can redeem this token for your cryptocurrencies whenever yothe u want.
How To Join the Liquidity Pool
The more traders buy and sell the ETH/USDC pair, the more fees you will earn.
Liquidity Pool Risks: Impermanent Loss
Liquidity Pool Formula: x * y = k
Let’s take our ETH/USDC pool as an example for reference.
We contributed 1,000 ETH and 1,000 USDC (a US dollar-pegged stablecoin) to the ETH/USDC liquidity pool. Since adding our cryptocurrency to this pool, the value of ETH has surged significantly.
As a result, traders have been buying ETH and selling USDC from our pool. Consequently, our amount of ETH has decreased while our amount of USDC has increased.
Although the total value of our pool remains the same as our initial investment of $2,000, we would have earned more if we had simply held onto ETH instead of contributing to the liquidity pool.
This situation illustrates what is known as impermanent loss.
What Are the Costs Involved in Trading on a DEX?
When you trade on a DEX, you incur trading fees, and when you provide liquidity on a DEX, you earn fees. But what exactly are these fees?
There are two types of fees to consider when trading on a DEX:
- Protocol Fee
Every decentralized exchange (DEX) charges a transaction fee. Usually, this fee is 0.3% of the transaction value. A portion of this fee goes to the protocol, while most of it compensates liquidity providers.
- Gas Fee
All blockchain transactions must be validated to be added to the blockchain. On the Ethereum network, stakers perform this validation work.
However, this process incurs costs. Gas fees can vary significantly. Currently, the gas fee to convert one Ether to one USD Coin on the Uniswap decentralized exchange (DEX) is approximately $2, thanks to the Uniswapx feature.
Most Trending 4 Decentralized Exchanges:
In the world of DeFi, we use the term TVL (total value locked) to assess the value of a protocol.
A higher TVL indicates greater value, trading volume, and liquidity for a decentralized application (dApp). Now, let’s take a look at the top four decentralized exchanges (DEXs) ranked by their TVL according to DefiLlama.
- Uniswap
- TVL: 5.86B
- Chains: Ethereum, Arbitrum, Optimism, Polygon, Fantom, Avalanche, Moonbeam, Kava, BSC (BNB Smart Chain), Celo, Manta, plus eight more.Â
- Fees: 0.3%; varies
- Curve DEX
- TVL: $2B
- Chains: Ethereum, Arbitrum, Celo, Optimism, Polygon, Avalanche, Base, Kava, Gnosis, Fraxtal, and six more.Â
- Fees: Varies
- PancakeSwap
- TVL: $1.96B
- Chains:Â BSC (BNB Smart Chain), Aptos, Ethereum, Arbitrum, zkSync Era, Base, Linea, Polygon.Â
- Fees: 0.25%; varies
- Balancer
- TVL: $1B
- Chains: Ethereum, Arbitrum, Polygon, Gnosis, Avalanche, BaseÂ
- Fees: Varies
DEX Aggregators
DEX aggregators are protocols that offer access to multiple DEX liquidity pools through a single interface. This integration allows traders to select protocols that provide the best rates and liquidity.
One of the most popular DEX aggregators today is the 1inch Network.
Conclusion
DEX aggregators are protocols that offer access to multiple liquidity pools from various decentralized exchanges (DEXs) through a single interface.
This integration enables traders to select the protocols that provide the best rates and liquidity. The 1inch Network is currently one of the most popular DEX aggregators.
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What Is Cryptocurrency And How Does It Work?
What is a DEX in crypto?
DEX, or decentralized exchange crypto, refers to platforms that facilitate peer-to-peer cryptocurrency trading without relying on a central authority.Â
What is the best DEX crypto?
The best DEX as far as liquidity and security, is generally considered to be Uniswap.
What are examples of DEX in crypto?
Examples of DEX in crypto include Uniswap, SushiSwap, and PancakeSwap.
How do I get DEX crypto?
In order to interact with a DEX in crypto, you must first connect a self-custody crypto wallet.Â
What does a DEX crypto do?
A DEX allows users to trade cryptocurrencies directly with one another via liquidity pools without an intermediary.
Zach Cooper is an experienced Crypto & Financial news journalist, having written for Moneycheck.com, The wall street, Computing.net and is Editor in Chief at wallstreetsights.com
