Just a few weeks ago, the incident at the brokerage Robinhood caused panic. Robinhood is actually a representative of the decentralization of the financial market. After many investors joined forces to speculate the shares of Gamestop, Robinhood temporarily suspended trading of some stocks. And this is the problem solved by the DeFi trading platform.
Decentralized exchanges (DEX) have made great progress in recent years and have now become an indispensable part of the DeFi field. But how does DEX work and what are the important considerations?
Decentralized exchanges (DEX) gained popularity after decentralized financial products (DeFi) were hyped. But the enthusiasm for the decentralized exchange Uniswap has once again triggered a debate about the pros and cons of decentralized exchanges and centralized exchanges (CEX). Many crypto enthusiasts believe that the market share of decentralized exchanges may increase substantially in the future. Many mature crypto exchanges are currently developing decentralized versions of exchanges. Therefore, there are reasons to look at the characteristics of different types of exchanges. Will crypto trading really be completely decentralized in the future?
A centralized exchange, such as Binance, has its own order book. Here, every order is recorded and verified. In order to ensure correctness, data is transmitted internally through a dedicated server and passed through a centralized security program. Normally, CEXs operate under supervision and have built-in extensive customer-knowledge policies. At the same time, centralized exchanges actively crack down on fraudsters and follow applicable laws to prevent money laundering. Beginners especially like to use this type of exchange, because the centralized structure can provide a user-friendly platform that makes buying and managing digital currencies particularly easy.
Order volume and transaction volume are usually much higher than DEX. This is also because no real-time update of network nodes is required. Therefore, the transaction speed is very high. However, the aforementioned simplicity of the platform requires that the private key of the integrated wallet is still exchanged. Therefore, access to encrypted assets is directly related to the user’s credentials. If fraudsters obtain credentials through phishing or hacker attacks, they will directly obtain the stored encrypted assets.
Behind a CEX is a for-profit company. In order to create a good user experience, these companies usually provide a wide range of support services. They also allow fiat currencies to purchase cryptocurrencies, usually with a wide range of trading pairs. Centralized transactions have fixed fees during transactions. Conceptually, the working principle of a crypto exchange is the same as any other exchange. The matching algorithm regulates supply and demand, and the order book stores the user’s orders.
Especially newbies to cryptocurrency attach great importance to convenience. In the beginning, trading and choosing the right platform are very beneficial in the long run. In this case, it is a good idea to start with a reliable, multi-certified platform. The simple interface makes trading relatively easy.
Centralized and decentralized exchanges
The first important difference between a centralized trading platform and a decentralized trading platform is that you do not need to register for DEX, nor do you need to verify (KYC). DeFi transactions are usually carried out directly between the wallets of two users. Rewards usually incentivize users to provide tokens in so-called liquidity pools to ensure the liquidity of DEX and avoid large price fluctuations.
The DeFi exchange also allows us to take an important step towards independence: on a centralized platform, you must entrust your money to the exchange, but in DEX, the transaction is carried out on the blockchain, and the funds are Assigned to users in their own database. No one keeps the user’s funds, so you don’t have to give up control at any time.
DEX-What are the decentralized exchanges and how do they work?
Just last year, DEX sprung up. Nevertheless, the most famous DEX may still be Uniswap.
On Uniswap, there is no order book or centralized trading party. Uniswap allows users to conduct transactions without intermediaries, with a high degree of decentralization and censorship resistance. DeFi Exchange is a decentralized trading protocol based on Ethereum. Uniswap’s mode of operation is to create a liquidity pool by liquidity providers.
Therefore, Uniswap put aside the traditional structure of digital exchanges. It uses a constant product market maker design, which is a variant of a model called automatic market maker (AMM).
The automatic market maker is a smart contract, which holds a liquidity pool and traders can trade on it. Liquidity providers fund these reserves. Anyone who deposits the equivalent of two tokens into the pool can become a liquidity provider. In return, traders pay fees to the pool and distribute them to liquidity providers based on their share in the pool.
Headquartered in Stuttgart, DeFi Startup is a DEX that can compare the prices of different decentralized exchange platforms, allowing users to trade at the best price. You can also split transactions between different DeFi platforms to get the best price. To this end, 1Inch uses different DeFi trading platforms, such as Uniswap, Kyber Network, Balancer, etc.
pros and cons
What are the benefits of buying on a decentralized exchange?
KYC/AML (Know Your Customer and Anti-Money Laundering) compliance is the standard of many exchanges. For regulatory reasons, individuals are usually required to provide identification documents and proof of address. On the other hand, DEX is accessible and anonymous to everyone. All you need to exchange on DEX is an encrypted wallet.
There is no listing process on the DeFi platform. Basically, as long as there is a liquidity pool for traders to use, any ERC-20 token can be launched. Therefore, tokens that are not listed on the central exchange can still be freely traded on DEX, as long as there is a supply and demand relationship.
No counterparty risk
The main attraction of DEX is that they do not hold customer funds. The more common hacking attacks on centralized exchanges cannot put users at risk, and sensitive personal information does not need to be disclosed.
What are the disadvantages of DeFi exchanges?
As each step moves toward independence, the user’s autonomy will increase. For novices, the centralized trading platform provides a more forgiving solution. If you forget your password, you can reset it easily. However, if you lose the seed phrase or private key in DeFi, the funds will be irrecoverable and the account cannot be recovered. Therefore, it is more important to be responsible for your own private keys and passwords in DeFi.
Especially people who are new to cryptocurrency attach great importance to convenience. At the beginning, trading and choosing the right centralized platform are very beneficial in the long run.
Author/ Translator: Jamie Kim
Bio: Jamie Kim is a technology journalist. Raised in Hong Kong and always vocal at heart. She aims to share her expertise with the readers at blockreview.net. Kim is a Bitcoin maximalist who believes with unwavering conviction that Bitcoin is the only cryptocurrency – in fact, currency – worth caring about.