Wednesday, November 30

What is a Decentralised Exchange and How does it work?

Decentralised Exchange (DEX)

The foundation of decentralisation is based on the concept of eliminating intermediaries, along with the fees, risk, and privacy concerns that come with it.

Decentralised markets that we have been seeing in everyday life include real-estate and foreign exchange. Forex traders ascertained a rate by communicating with other forex traders around the world. There is no fixed place where one can exchange currency. Similarly, real estate requires a buyer and a seller to agree at a certain rate to finalise a transaction. There is no singular place for buyers and sellers to go through an intermediary to fix the rate and control the transaction.

Blockchains like Bitcoin are decentralised and Decentralised Finance (DeFi) is also swiftly gaining popularity.

Decentralised exchanges (DEX) also use blockchain technology. Through peer-to-peer (P2P) trading, transactions are carried out in the absence of any intermediary. Typically, automated smart contracts are used to carry out these transactions. 3% of the crypto trading market share is through DEX. More than 100 million investors trust DEX platforms, trading 4 million USD on average per day.

As an example, for cryptocurrency trading, you deposit money with a centralised exchange. You then received a cryptocurrency of the same value in your wallet, held by this exchange. To withdraw, you again had to initiate another transaction.

Essentially, your wallet on the cryptocurrency exchange is owned by the exchange itself. You can trade the value of the wallet, but in principle, you don’t control it. The centralised system, being the cryptocurrency exchange, holds it. Think of this as an Amazon Pay account or a bank account. You can deposit and withdraw at any time, but Amazon or the bank owns the account.

The centralised exchange, in turn, ensures that there is continuous demand and supply for you to trade your cryptocurrencies freely.

However, you are trusting the exchange with your money, thus inheriting some amount of risk. The risk is the privacy concerns around your information which you share at the time of onboarding the platform, and maybe even a third person breaching the security and hacking the system. However, some investors still choose to trust the best cryptocurrency exchanges with a good reputation and a stellar track record, accepting this level of risk.

With DEX, users have complete control over their cryptocurrencies. Relying on the concept of on-chain order books, every element of a transaction is recorded on the blockchain, giving complete transparency to the owner of the currency.

In order to make DEXs faster and a more lucrative option, the Automated Market Makers (AMM) came into the limelight. Finding a buyer or seller willing to trade the digital asset you own at your desired price may be extremely cumbersome. AMM uses blockchain technology to automate this traditional trading process. Users can earn a fee by supplying tokens to an AMM’s liquidity pool every time the assets are being traded from their pool. At its core, AMM creates numerous pools and provides ready marketplaces, eliminating third-party interactions

  • No need for sharing personal information or any formal documentation
  • No third-party mediation holding your funds for you
  • No need to find a centralised exchange that has your token listed
  • Lesser risk of losing your resources because of a security breach
  • Demand and supply might not be readily available
  • A high gas fee might be charged to finalise an individual transaction
  • Beginner-friendly features of centralised exchanges are not always available

Based on your risk appetite, you can choose which option to go for, between centralised and decentralised exchanges, based on your risk appetite. Make sure you do your research and opt for the best cryptocurrency exchanges in India. To begin your trading journey, check out Zebpay, a safe and secure platform for crypto trading in India.

Sources:

https://academy.binance.com/en/articles/what-is-a-decentralized-exchange-dex

https://www.investopedia.com/terms/d/decentralizedmarket.asp

https://www.fool.com/investing/2021/09/30/what-are-decentralized-exchanges/

https://www.gemini.com/cryptopedia/amm-what-are-automated-market-makers

https://www.ndtv.com/business/what-are-decentralised-crypto-exchanges-2579017