October 5, 2021

The number of cryptocurrency projects has exploded in recent years. However, part of the excitement of the crypto space is shifting toward exchanges. Decentralized exchanges promise to offer greater access to a wide audience.

What Is a Decentralized Exchange?

 

Decentralized exchanges, or DEXs, are platforms where the exchange of cryptocurrency can occur on a peer-to-peer level. Two parties come together to trade their respective digital assets with the exchange operating as a go-between in the transaction.

Origin of DEXs

 

As a concept, the idea of DEXs comes from the world of traditional finance. The idea of being able to purchase stocks or other instruments without the intermediation of a financial institution has been around for years. In time, purchasing financial assets has become easier for retail investors, albeit still regulated by authorities.

Since blockchain technology has revolutionized the way investors think about finance, a growing number of transaction types are occurring through crypto-enabled methods. Specifically, peer-to-peer lending, payments and smart contracts are all innovations due to blockchain technology. Providing the architecture for the decentralized trading of digital assets is a natural progression and fulfills several purposes for crypto investors.

Ethereum founder, Vitalik Buterin, was the first to propose the creation of a framework for organizing a DEX. His concept of an Automated Market Maker as a way of guaranteeing liquidity serves as a price discovery mechanism that operates based on supply and demand. Since Buterin’s proposal of the AMM, other frameworks have been developed.

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How Are Centralized and Decentralized Exchanges Different?

 

Exchanges have the task of pairing buyers and sellers. The price at which a transaction occurs is a product of supply and demand. In the case of centralized exchanges, an intermediary is responsible for facilitating the change of ownership of the cryptocurrency.

As per the experts at SoFi :

Until recently, some investors have been limited to investing in digital assets through centralized exchanges that don’t align with the ecosystem’s core philosophy. This inconsistency inspired the creation of decentralized exchanges, which provide a decentralized platform to exchange assets without having to trust their funds with another entity.

 

This is the main difference between centralized and decentralized exchanges as the latter does not have a central authority to manage transactions. Furthermore, decentralized exchanges are not custodial. This means that investors do not have to give control of their crypto to the DEX for the trade to occur.

 

Centralized exchanges take custody of crypto from all parties that wish to transact on these platforms. Furthermore, they require Know Your Customer procedures, known as KYC. This entails exchange participants undergoing a process where their identity is verified. Decentralized exchanges offer anonymity as are not yet subject to KYC.

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A further difference between the two types of exchanges is the availability of cryptocurrencies listed on the platforms. Centralized exchanges tend to have many different assets available due to the large number of users they possess. DEXs usually have a smaller selection of cryptos but the gap between the two types of exchanges is constantly closing as more people are rushing to the decentralized model of trading.

 

The Future of Decentralized Exchanges

 

Decentralized exchanges such as Uniswap are gaining more users as retail investors overcome the learning curve associated with trading cryptocurrencies. Various projects are rushing to become the dominant player in the decentralized exchange space. This will only create a flourishing ecosystem where DEXs will assume a greater role in the blockchain space.

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