A DEX or decentralized exchange is a blockchain-based exchange that allows traders to exchange encrypted tokens directly with one another.
It does not store user funds and personal data on the server, but performs all operations through smart contracts in the blockchain, which are different from traditional central exchanges (CEX). Merchants can conduct direct peer-to-peer transactions on a DEX with no middlemen. Just like centralized crypto exchanges, they have advantages and disadvantages.
First, we need to understand the mechanism of operation and the difference between a CEX and a DEX.
Central exchange operating mechanism
In centralized exchanges like Binance and Coinbase, all of the core steps of transactions, including topping up, placing orders, order matching and delivery, and cash withdrawals, are performed on the exchange. For example, investors are required to provide their bank statements and some identity information before depositing money on the platform to buy cryptocurrencies.
Traders don’t actually hold the digital assets, however. Rather, they entrust their stocks of virtual currencies to the exchange and all transactions take place in the database of the central exchange.
In other words, this is similar to a traditional banking business. The customers deposit the principal amount with the bank. The bank will then give you a bank accountThis corresponds to the existence of a private key in a central cryptocurrency exchange. However, the bank has ultimate control.
DEX operating mechanism (Decentralized Exchange)
Decentralized exchanges use smart contracts to facilitate the transaction of tokens but do not enjoy control over tokens. First, orders via authorized smart contracts are added to the DEX order pool so that other users can view them. Other users can choose to run the job. After confirmation, the relevant transaction information is uploaded to the chain and the entire transaction process is completed by a smart contract. Therefore, decentralized exchanges such as Uniswap, 1inch, Balancer and SushiSwap are dependent on the blockchain infrastructure for operation.
DEX offers three options for processing orders: on-chain order book, off-chain order book or automatic market maker method.
Benefits of DEX
On a CEX, the wallet stores all users’ funds, making a large amount of funds vulnerable to hack attacks. Once a problem arises, the consequences are catastrophic, which is why DEX is safer by comparison.
With a DEX, the platform is responsible for providing liquidity for transactions without controlling actual assets.
The decentralized exchange protects users’ personal information, and users who perform the decentralized exchange do not need to provide personal information such as social security numbers or addresses.
Disadvantages of DEX
Compared to a CEX, a DEX has a slower transaction speed and higher cost. Since every transaction record is recorded on the blockchain network, more computing power is required, which makes transactions slower.
Compared to a CEX, a DEX does not provide adequate customer service, which makes the user experience less than optimal than a CEX.
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