What is a Decentralized Exchange (DEX)?

A decentralized exchange or DEX is a cryptocurrency exchange platform that does not depend on a central authority (that is, there is no company behind managing its operation). Everything that happens on a DEX depends on smart contracts that run on a blockchain, eliminating intermediaries in all transactions.

Whether you are new to the world of cryptocurrencies, y blockchain, as if you already have knowledge, it is very likely that you have heard about exchanges. These are digital exchange houses where you can exchange cryptocurrencies and tokens for fiat money or other cryptocurrencies. And where the value of cryptocurrencies is determined by the supply and demand of crypto assets in the market.

What are decentralized exchanges (DEX)? There has been a lot of talk about this type of exchange since the boom in DeFi, especially because of the level of security they offer the user and the anonymity options.

Decentralized exchanges, also known as DEX, They are digital platforms that function like traditional exchanges. However, unlike traditional exchanges, these are operated by smart contracts.

Its main feature is that intermediaries are eliminated, making them safer and more transparent. Simply put, a decentralized exchange, or DEX, is a cryptocurrency exchange operated by smart contracts.

In this way, the trust and management of the funds does not fall on a central figure, but the users of the exchange maintain control of their assets at all times. A feature that adds a high level of security, privacy and anonymity, when operating in this type of exchange houses.

Origin of decentralized exchanges

Cryptocurrency exchanges have come a long way since the creation of the first of these platforms.

Initially, exchanges like Mt Gox. they followed a centralized management and interaction model. That is, the exchange controlled the funds we have in it. And to perform operations it was necessary to log in. This goes against the decentralization of cryptocurrencies and creates serious security problems, as demonstrated by the Mt Gox hack.

To deal with this and other problems presented by centralized exchanges, decentralized ones were born. Some of the first platforms of this type were OmiseGo and BitShares that began to be developed in 2013. Each of them has different functions and capabilities, but they shared a goal: start the decentralized exchange revolutions.

Types of exchanges

The evolution of these platforms has given rise to three types of exchanges or generations, well differentiated:

1. First generation: Despite being a relatively new concept, decentralized exchanges already have differentiated versions. On the one hand, we have the traditional, centralized exchanges, with which you lose absolute control of your cryptocurrencies and blindly trust the good work of the platform. We can call these centralized Exchanges, but also first generation.
2. Second generation: On the other hand we find the most basic decentralized exchanges, the second generation ones. These change central governance for a smart contract, which is in charge of making the exchanges. As a smart contract, everyone can see how it works. However, in these smart contracts you must send your cryptocurrencies, losing possession of them for as long as you want to make the exchanges.
3. Third generation: A new generation of decentralized exchanges improve this last point, allowing you not to have to send your cryptocurrencies anywhere, despite being able to open exchange orders with them. In the same way, they act through a smart contract, but they allow you to keep the cryptocurrencies in your wallet at all times, so if those tokens give you dividends, or voting options in a DAO, you can do it until the last millisecond of the exchange.

Blockchain technologies for DEX

Although Ethereum It is the most used platform for this type of development, due to the large number of projects (Tokens y DApps) that is being developed on it, there are other blockchain that also allow this, including Bitcoin through the project Counterparty. Some other blockchains that allow creating decentralized trading platforms are: Stellar, Komodo, Waves, BitShares, NEO or burning among others.

DEX Advantages

Reliability

Everyone can transparently see how the service works, how it will act in any situation and see what happens within it in real time, without manipulation.

Protection and security

Hundreds of millions of euros are stolen from centralized exchanges every year. Only in 2018, more than 1000 billion euros were stolen from centralized exchanges.

In DEX smart contracts can be implemented as a protection against scams and fraud. Thus, when establishing a contract with certain conditions to be fulfilled, the parties involved in the exchange must obey these conditions for the operation to be executed. In case of breach of any or all the conditions, the contract expires and is not executed. Best of all, these contracts, once scheduled, run automatically and decentralized.

Furthermore, DEXs work through a network of computers interconnected with each other, in much the same way as a blockchain network. So they have high protection against hacks or computer attacks that threaten the integrity of user funds.

However, decentralized exchanges (especially second generation ones) can also suffer from theft, since all funds are held by a smart contract that may contain flaws, such as the famous billionaire robbery The DAO.

Anonymity

A high degree of anonymity is another advantage they can offer. This is because a decentralized exchange (DEX) only uses addresses to carry out transactions and exchanges. Without requiring users to supply data and personal information.

Robustness

Another advantage of decentralized exchanges is their robustness and solidity. The probability of a DEX system crash is almost nil; so users will not have to worry about this problem. This is because DEXs do not operate with a single server, as is the case with centralized exchanges.

Disadvantages or disadvantages of DEX

Usability

At first, without knowledge, the DEX platform can seem confusing and difficult to operate. Therefore, the guidance or instruction of an expert user is almost always necessary to understand them and start operating on them.

Limited

A decentralized exchange (DEX) does not serve to make exchanges between cryptocurrencies of different blockchain. Since Ethereum is the network with the most tokens, the most famous decentralized exchanges are from this network. But for example you can't exchange Bitcoin for Ethereum, only Ethereum tokens for other Ethereum tokens.

Types of orders

The types of orders that can be placed on a decentralized exchange are very limited, being able to place only Limit and Market type orders.

operation time

Since exchange operations take place within the same blockchain in DEX, their process is much slower than in a centralized exchange. So a decentralized exchange cannot manage high frequency.

management

The most important thing about a trading platform is liquidity, which in turn generates low spreads. A decentralized exchange (DEX), due to its lack of manipulation capacity, usually has little liquidity, in turn generating little traction that turns back to little liquidity and high spreads. Something that drives away any user.