Decentralized exchanges (DEX) are a type of cryptocurrency exchange which allow direct peer-to-peer cryptocurrency trading to take place online securely and without the need for an intermediary. Unlike centralized exchanges, DEX’s are non-custodial and don’t require you to entrust third parties with your funds. Instead of signing up with an email address and password, submitting documents and verifying your identity users can simply begin trading directly from their web3 enabled wallet and browser. Another benefit is that adding new tokens is permissionless, meaning that anyone can add liquidity and add a new token without authorization.
There are typically three broad categories of DEX, each distinguished by the type of orderbook. On-chain orderbooks, Hybrid orderbooks, and AMM exchanges. We will go into further detail into AMM’s in a separate article.
In the past, DEX’s had higher trading fees, were less liquid, and had limited trading speed compared to centralized exchanges. However, the newest generation of DEX’s are leveraging Layer II, faster blockchains, and utilizing advanced algorithms which have reduced transaction fees, increased trading speed, and decreased fees. Thanks to all of these advancements DEX’s are occupying an increasingly large share of total trading activity.
As the performance gap between DEX’s and traditional exchanges continues to narrow, some have forecasted that centralized cryptocurrency exchanges may become obsolete as DEX technology continues to advance and improve liquidity, security, and volume. Users of DEX’s also benefit from greater privacy and security.
DEX’s also introduce inventive monetary incentives which can create community goodwill. Including profit sharing and token issuance entitling token holders to a pro-rata share of all revenue generated by the trading platform. Furthermore, certain DEX’s reward users for providing liquidity to certain trading pairs to help facilitate smoother trading experiences.