.jpg)
Decentralized Exchanges: What Is A DEX & How To Use One?
The SOMA.finance guide to getting started with a DEX.
- The meaning of DEX is Decentralized Exchange (DEX), a peer-to-peer marketplace where transactions take place directly between crypto traders.
- DEXes fulfill one of the original tenets laid out by Satoshi Nakomoto in the Bitcoin whitepaper: helping to foster financial transactions that aren’t officiated by banks, brokers, payment processors, or any other kind of intermediary.
- Decentralized exchanges are a foundational part of the decentralized finance ecosystem, which some suggest didn’t really get established until one of the most popular DEXes, Uniswap, helped put a spotlight on the sector in what became known as “DeFi Summer” during the summer of 2020.
How a DEX works
If you’re wondering what a DEX is, you've come to the right place. As opposed to managed “order books” that are run by brokers, decentralized exchanges utilize a set of smart contracts to establish the prices of various cryptocurrencies against each other algorithmically.
Liquidity pools that are funded by users of the platform and other market makers are harnessed to facilitate trades, with portions of the trading fees being redirected to the liquidity providers as a reward for the risks involved with providing liquidity.
DEX exchanges or transactions are recorded directly on the underlying blockchain that they operate on, meaning anyone can view and verify any trade that takes place. Most DEXs are built with open source code, meaning developers can adapt existing code to create new competing projects. This is the mechanism by which multiple spinoffs of the Uniswap interface have appeared on DEXs across the crypto ecosystem, including SushiSwap, QuickSwap, and PancakeSwap.
Benefits and downsides of DEXs
Benefits:
- Maintain anonymity – No KYC/AML required
- No counterparty risk – Users maintain control of their funds the entire time
- Access to unlisted tokens before they are added to centralized exchanges, which often results in a notable price increase.
- Utility in the developing world often lacks good banking and financial services
Downsides:
- DEX exchanges can be difficult to use and are not as user-friendly as CEXs
- Less fail-safes in place, which increases the potential for lost funds
- Lower trading volumes and token liquidity than on CEXs – can lead to a greater difference in the bid and ask prices.
- Can be difficult to find the trading pairs desired due to low supply and/or demand
- Smart contract vulnerabilities that can lead to protocol hacks/loss of funds
- Riskier/Unvetted coins that could be scams or “rug pulls”
How to interact with a DEX
Most decentralized exchanges in operation today require users to connect with them using a cryptocurrency wallet like the software wallet Metamask or a hardware wallet like a Trezor.
Typically, DEXs can be accessed on their official website through a computer’s web browser, where users can click a button that says “Connect to a wallet” to get started.
Once a wallet is connected and has a sufficient amount of the underlying cryptocurrency that is required to pay for transaction fees (known as gas), swaps can be conducted through the protocols swap interface using any funds already held in the wallet.
What is the fee for using a DEX?
Fees vary from DEX to DEX but generally run in the 0.3% to 0.5% range. The proceeds from fees are split, with a portion going to liquidity providers while the remainder is a protocol fee that is often deposited in the protocols Treasury.
The other main fee involved in a decentralized exchange is the gas fee, which in the case of the Ethereum network, can often dwarf the swap fees charged by the DEX. Luckily, there has been a concerted effort to create cross-chain bridges between different blockchain networks with many popular DEXs offering multi-chain support, which gives traders several different options when it comes to which network to conduct trades on. This includes separate layer-one networks like Avalanche and BNB Smart chain, as well as Ethereum layer-two solutions like Polygon and Arbitrum.
This material is intended to be of general interest only and should not be construed as individual investment advice or a recommendation or solicitation to buy, sell or hold any security or to adopt any investment strategy. It does not constitute legal or tax advice. The views expressed are those of the author and the comments, opinions and analyses are rendered as of the publication date and may change without notice. There is no guarantee that any forecasts or predictions made will come to pass. The information provided in this material is not intended as a complete analysis of all material facts or circumstances regarding any country, region or market. All investments involve risks, including possible loss of principal.
Risk management does not imply elimination of risks, and not all investments are suitable for all investors.The information and opinions contained in this material are derived from proprietary and non-proprietary sources deemed by SOMA.finance to be reliable, are not necessarily all inclusive and are not guaranteed as to accuracy. Data from third party sources has not independently verified, validated or audited. SOMA.finance accepts no liability whatsoever for any loss arising from use of this information; reliance upon the comments, opinions and analyses in the material is at the sole discretion of the user.
Any products, services and information in this material may not be available in all jurisdictions and are offered local laws and regulation permit. Please consult your own financial professional or legal advisor for further information on availability of products and services in your jurisdiction. Please also see the disclaimer which is found at the bottom of this website under the heading “Important Disclosures”.