Cryptocurrency market capitalization hit its maximum levels recently at the level of $2,5 trillion, attracting institutional investors despite the current market pullback. Bitcoin, as usual, is maintaining the leading position with Ethereum in the second place. The Crypto market is still new compared to the other financial markets but experiencing much higher volatility, attracting traders from all over the world. Ethereum, with its smart contract functionality, enabled the rise of decentralized exchanges, which we will describe in this article.
What are the decentralized crypto exchanges?
A decentralized exchange or DEX is where people can go to trade cryptocurrencies without an intermediary and KYC procedures. The exchange is very simply said, “the smart contract”; hence there is no central point of failure or possibility to shutdown.
Decentralized Crypto Exchanges (DEX) have gained popularity not only since the hype of decentralized financial products (DeFi). But the rush to the decentralized exchange Uniswap reignited the debate about the pros and cons of decentralized and centralized exchanges (CEX).
Uniswap is a decentralized finance protocol that is used to exchange cryptocurrencies started in November 2018. Uniswap is also the name of the company that initially built the Uniswap protocol. The protocol facilitates automated transactions between cryptocurrency tokens on the Ethereum blockchain through the use of smart contracts.
What are the top decentralized crypto exchanges
Many crypto enthusiasts, including me, believe that Dexes’ popularity will only increase, which seems to be true if we look at the chart below, which indicates the DEX to CEX Spot Trade Volume in % or the overall DEX volume trend going up. You can see below also the top decentralized exchanges by volume.
A cryptocurrency trader can become the liquidity provider
Before we dive deeper into DEX advantages, I would like to explain how the exchanges work behind the scene. All the exchanges need liquidity to work properly. There are mostly external market makers in central exchanges (CEX), which maintain the volume and liquidity on any pairs. The traders should not experience any liquidity issues or possible slippage.
The traders can become the liquidity providers in decentralized exchanges; hence the Dex works as AMM ( automated money maker) too, which is a unique idea despite some risks mentioned later. They can benefit from trading fees but risk impermanent loss.
Uniswap charges a 0.30% fee on all trades, which is after added to the reserve pool. When a liquidity provider burns their pool tokens to reclaim their stake of the total reserve, they receive a proportionally distributed amount of the total fees accumulated while they were staking.
Why are decentralized crypto exchanges so popular?
Cryptocurrencies underlying technology is blockchain what for most people means transparency. That is also reason enough to take a look at the characteristics of decentralized exchanges and why they are so popular. Will crypto trading really become fully decentralized in the future? Let’s have a look at some of their features :
- Non-custodial – Ownership of the underlying assets is never revoked. Your Private Keys Your Bitcoin is the point we follow here. You can connect to any DEX via hardware wallet and Metamask what makes your crypto secure.
- Automated – With no intermediaries, DEX trading is instantaneous so long as there is sufficient liquidity. If there is low liquidity, the trader can experience slippage.
- Cost-Efficient – Many DEXs have minimal trading fees, allowing users to swap assets at little to no cost. This is depending on the current blockchain network congestion.
- Globally Accessible – Most DEXs do not require any sign-ups, and largely come with no counterparty risk. There is also no KYC needed.
- Intuitive – Newer trends have evolved DEX trading from order books to simple point and click swaps. The Uniswap was one of the first and the following Dexes just forked their code.
- Pseudo-anonymous – Users simply connect a wallet of their choice to start trading. No profile or background information is required.
- Continuous Growth – the whole crypto field is changing dramatically fast as new technologies. This is valid also for Dexes since it is open-source code there are new updates in favor of traders coming out quite often.
- No regulations – since it is a smart contract behind the DEX that can not be shut down running on the decentralized network any regulation rules can not be imposed
- Wide choice – the Dexes can run on the various network like Ethereum, Binance Chain, Polygon – the trader has a wide variety of possibilities where to trade
- Variety of tokens- since anybody can list its tokens there is no need to wait for approval and the project can easily provide the token for their communities
What are the decentralized crypto exchanges disadvantages?
Regarding the technical development and mainly thanks to Uniswap leading we have many DEXs to choose from, but there are a few of the boxes you should be sure to watch or carefully evaluate.
- Slippage – The biggest thing to note when using a DEX is the slippage associated with the trading pair. As a general rule of thumb, the more obscure the pair (i.e. exchanging tokens with small respective market caps) the more slippage there will be. Almost every DEX will display the expected slippage under their “Advanced” options.
- Front running bots – all the transactions are visible on the blockchain hence there are bots front running you and increase your price using higher Gas fees – that is the reason you should manually set up the maximum slippage
- Impermanent loss – if you decide to provide the liquidity there is risk involved. Impermanent loss happens when you provide liquidity to a liquidity pool, and the price of your deposited assets changes compared to when you deposited them. The bigger this change is, the more you are exposed to impermanent loss. There are already some solutions that mitigate these risks.
- High fees – this not the particular issue of the DEX but more the underlying blockchain network congestion like often happens in the case of Ethereum
- No Limit orders – on the majority of Dexes you can not place the limit order
- Technically complicated – to use the Dex can be complicated for some of the traders
- Scam tokens – anybody can list a token on the DEX just providing the liquidity. Be sure you always check the correct smart contract. Mainly if there are new tokens coming out there can be already a couple on the market usually scams that you buy but never sell.
- You are responsible!! – Projects which have community-backing are often most active on social media. If you’re on the fence about using a DEX, check out their Twitter or Telegram community to see if the community is engaging with their posts as a signal of trust.
- No customer service – there is no place where you can write any concerns
Where is the future of Decentralized crypto exchanges?
The Uniswap trading was the trigger of the Defi summer 2020 altcoin bull run when many coins made huge profits. We have spotted major technical developments from that time which include not only the technical updates of the current DEXes like in the case of Uniswap V3 recently launched but also DEXes on the new protocols and ETH layer 2 like Quick Swap, Pancake Swap, etc.
The trends we currently observe on the market are :
- DEXes interoperability – not only in the overall crypto field but also in trading, there is an interoperability need. Suppose you can trade any crypto-asset on one exchange. A great example is the Dfyn exchange project we have described here.
- Technical updates – better security, user interface, liquidity, and other points are the subject of change like with Uniswap V3.
- No Impermanent loss – there are projects already implementing this like VISR, Dfyn.
- New functionalities like limit orders – stop losses – also here the updates are coming line Gelato project.
- DEXes for leverage trading, stocks, and other financial assets is a huge step for financial inclusion. Some projects work continuously to bring these features like DEA protocol, Mirror, etc.
The concept of the DEX is gaining a lot of traction, as the cryptocurrency community recognizes its benefits amid ongoing hacks, temporary service incidents involving centralized exchanges. However, overall, the DEX is a closer fit with the decentralized ideology of cryptocurrency and blockchain. We are sure that it is only a matter of time before the rise of the DEX consigns centralized exchanges to the history books. We will publish more content related to particular exchanges very soon.
There is much more coming, so stay tuned and follow us on our socials.