Overview of Decentralized Exchange
Decentralized exchanges operate on unique trade system called Automated Market Maker (AMM) rather than relying on centralized order book system. Moreover, users store their funds on self-custodial wallets which may or may not be integrated with DEXs. This means users have control over their private keys for storing funds. These qualities make DEXs more decentralized which means they are not fully managed by a company. Trades on these platforms are executed by smart contracts which are deployed by developers.
Decentralized nature of these platforms provides advantages such as self-custody of funds, reduced fees, global accessibility without regulatory constraints, wide range of crypto and innovative financial services like yield farming. However, there are also some associated risks.
How Decentralized Exchanges Work
DEXs introduced the Automated Market Maker system to simplify the trading process. Users do not need to register an account and complete a KYC process on the DEX. Instead, they connect their wallet to the platform to start trading. The trades are executed directly between users through the AMM system.
AMM system relies on liquidity pools funded by liquidity providers. These providers deposit their tokens in the pool, which typically consist of token pair. When traders purchase crypto A, they sell crypto B keeping the product of pool’s token quantities constant. The price is determined by constant product formula x⋅y=k, and is adjusted after each trade. Larger trades relative to pool size may cause slippage or significant price change. Smart contracts handle trade execution, update the pool balances, and reward liquidity providers with a portion of the trading fees.
To choose a DEX, consider factors like pool size, number of available pools, specific tokens available for trading, trade history, and trade fees. For beginners, DEX analytics tools can provide essential data about DEXs.
- Uniswap
Uniswap launched in 2018 on Ethereum blockchain, has remained the world leading DeFi platform for decentralized trading and other financial services. It is world’s largest DEX with highest trade volume recently reaching $2 trillion. Uniswap also introduced innovative AMM system to simplify trade. You can trade wide range of ERC-20 tokens and participate as liquidity provider, benefitting from its user-friendly interface. The trade fees can be high during network congestion of Ethereum blockchain. Also, you should be aware of possibility of impermanent losses if you want to start liquidity farming on this platform.
In 2020, Uniswap developers introduced UNI token through community airdrop as native token of Uniswap platform. This token played crucial role in community-driven governance of Uniswap. UNI holders can propose improvements, and community vote on these proposals. Moreover, upgrades from V1 to V3 and introduction of layer 2 solutions have brought improvements such as increased capital efficiency, concentrated liquidity, and customizable fee tiers.
- Pancake Swap
It is a popular decentralized exchange that was developed in 2020 by anonymous developers. Built on Binance Smart Chain, this platform offers low-cost trading. Just like most of the DEXs, it also uses AMM model to facilitate trades. Beyond trading, it also offers other financial services. You can also stake crypto, participate in liquidity farming and trade perpetuals, and NFTs. This comprehensive service offering has positioned Pancake Swap as leading DeFi platform and also boosted its popularity in recent years.
CAKE is the native token of Pancake Swap having versatile utility. This means, you can use this token for staking, yield farming, and for participating in governance. Moreover, lower fees, high liquidity and user-friendly interface are some of the features that makes this platform unique.
- dydx
Dydx was founded by Antonio Juliano in 2017 and built on Ethereum blockchain. It focuses on spot trading and advanced financial services like margin trading, and perpetual trading. These features make this platform suitable for professional traders. Furthermore, dydx leverages the StarkEx network, a layer 2 scaling solution to enhance trading experience for users. This reduced gas fees and increased the trade execution speed.
You can trade wide range of coins and tokens on this platform. Moreover, you also have option to use dydx token if you want to participate in governance. Interestingly, dydx uses off-chain order book system to facilitate trades. This enables margin trading and derivatives trading. Compared to AMM, order book also offers less price slippage in case of execution of large orders. So, dydx mitigates slippage to some extent. Overall, it’s suitable for professional traders but can be difficult to use for beginners.
- Curve Finance
It is another DeFi exchange built on Ethereum. It was founded in 2020 by Michael Egorov specifically to provide efficient trading services for DeFi traders. Curve Finance focuses on providing liquidity for stabelcoins, so users can trade these coins efficiently. Curve’s unique AMM algorithm reduces coin slippage and impermanent loss significantly. This enables stable prices and also incentivizes liquidity providers because the risk of impermanent loss is greatly reduced.
CRV being the native token of Curve, is used as governance token for various platform upgrades. Users can also stake this token on the platform to earn rewards.
- 1inch
It is a decentralized exchange aggregator developed by Sergej Kunz and Anton Bukov in 2019. Built on Ethereum blockchain, this platform was designed to simplify trading by providing best rates and trade paths. Rather than acting as exchange itself, it executes trade on various DEXs on best possible rate and returns the desired crypto to trader. It is made possible with its Pathfinder algorithm which determines best possible trade path considering factors like fees and liquidity. Wide range of tokens and coins are available and can be traded without experiencing much slippage. Unique thing about this platform is that it also allows limit orders to specify desired price for traders. Through the aggregation feature, users can enjoy deep liquidity for trading.