DEXs: The What, The Why & The How of Decentralized Exchanges

Project UpdateMarch 19, 2024
New image

In this article, we dive into Decentralized Exchanges. We explore the benefits, challenges, and differences between this model and classic centralized ones. Read through and understand why DEXs are gaining popularity with web3 users, what market makers are, and much more.

A Decentralized Exchange (DEX) is an exchange platform to trade tokens that operates without a central authority or intermediary. Instead of relying on a centralized entity — like a bank or another financial institution — to facilitate trades and hold assets, it allows users to trade directly with each other using smart contracts or other decentralized protocols. This approach offers greater privacy, security, and control over assets compared to centralized exchanges, which are vulnerable to hacking, regulatory scrutiny, and other risks. In this article, Hackernoon calls DeFi the “Wild West” of the finance world because it opens the door to a more global, free, and speculative world where users have control over their assets.

CEXs & DEXs: Main Differences

The first crypto exchanges to emerge were centralized, meaning they were controlled by an entity — much like any other financial hub like the housing market or the stock exchange. Convenient, secure, and offering high liquidity, and a wide pool of different assets, this kind of exchange is still the most popular amongst crypto traders.

However, DEXs are also making their way to the top, mainly due to its decentralized nature. Blockchain maximalists believe this is the way to go when it comes to trading — there are no intermediaries, so users have total control over their assets. It’s more private and secure. There are hundreds of DEX projects and although you might not know all of them, you’ve probably heard about UniSwap, PancakeSwap, SushiSwap, Curve, and HydraDX, which are the hottest decentralized exchanges right now.

Benefits of DEXs

In a way, DEXs are more secure because they operate with non-custodial wallets (a type of crypto wallet where the user has total control and responsibility over its private keys) and aren’t managed by an intermediary, thereby minimizing the risks of hackers accessing it. Since these exchanges are operated via algorithms and smart contracts, there’s no need for middlemen, thus eliminating the fees market makers request in CEXs. Trading in DEXs has a trustless nature because users don’t need to trust a central authority. Privacy is yet another benefit largely connected to decentralized platforms as you don’t have all the KYC requirements presented in CEXs.

Challenges in DEXs

However, there are a few things that can make trading in DEXs challenging. Decentralized exchanges offer a more limited offer of tokens, and the fact that it’s not regulated by an entity might make it less trustworthy — banks and other financial institutions operate under strict laws and regulations. DEXs typically have lower liquidity compared to centralized exchanges. This can lead to issues such as slippage, where the execution price of a trade differs from the expected price due to insufficient liquidity. Another disadvantage is related to the user experience — DEXs may not be as polished or intuitive as centralized exchanges. This can deter less experienced traders from using them. When it comes to transactions on DEXs, slowness and lack of scalability can also be an issue, especially when networks are congested, thus resulting in delays in order execution and confirmation times. Centralized exchanges have a wider availability when it comes to token diversity, which is better for traders who value variety in crypto. Another obstacle to the use of DEXs is the price fluctuation from platform to platform.

Market Making & Liquidity: A Match Made in Blockchain

Market makers were always fundamental pieces in the world of trading and exchange, but perhaps the most well-known ones are brokerage houses. These firms act as intermediaries between house buyers and sellers, ensuring both parties find what they want and get a fair deal. What do they gain with each business? A commission over every sale.

The same happens with market makers in blockchain. These firms or individuals are key in centralized crypto exchanges — they act as intermediaries as well, with the main goal of providing liquidity (by ensuring optimal demand and supply) to traders. In this The Block article, Tim Copeland sums it up pretty well: Market makers set offer prices and bid prices for trading pairs, and can step in as a buyer or seller in a transaction when there’s no suitable counterparty available (…) By continuously providing offer prices and bid prices, they ensure a high level of liquidity in the order books, which is essential for the smooth execution of trades”. In simpler words, market makers are wholesalers of the financial markets — this includes cryptocurrency ones. These people also shape market prices and behaviors in the sense that they are the ones setting the tokens’ values. Just like in every other financial market, a currency will be cheaper if the demand is low and the supply high, but it will become more expensive as the latter decreases, and the demand increases. In a way, market makers work as a market regulator.

However, traditional ones now have competition: the Automated Market Makers (AMMs), which operate in the decentralized exchanges. The main difference between these two models is that the latter works via an algorithm rather than actual people. It’s also more secure because the algorithm factor ensures continuous liquidity. AMMs are also open to more people — everyone can participate in trading and fees are much lower than the ones presented by traditional market makers. Decentralization is yet another attractive element of AMMs: they operate without intermediaries, making it a more autonomous service that can be controlled by the users themselves. There are also downsides to using this automated tool, namely price slippage.

Liquidity Provider and Their Role in DEXs

Anytime one opens a DEX app or website, there’s that expression: Liquidity Providers (LPs). But what are they and why are they so important in the context of decentralized exchanges? LPs are people (traders) who ensure the market’s liquidity by depositing cash (in the form of tokens) in a pool. That money represents the amount of each contribution in the liquidity pool’s total. In return for helping increase liquidity, LPs get LP tokens.

UniSwap: Three Versions, One Goal

UniSwap is the most popular and trusted DEX nowadays. It’s interesting to look at the evolution of this platform since v1 was released by Hayden Adam, in November 2018. Since then, two more versions have been launched, and although v2 and v3 present updates and improvements to v1 all three are simultaneously operational. Like in many other DEXs, Uniswap also has LPs adding liquidity and the exchange allows the LP tokens to be staked or burned to get rewards — there’s a trading fee of 0.3% associated with the process of redeeming these.

There are major differences between them: the first one — also known as beta — was mostly a proof-of-concept. Users could trade and there was a high level of liquidity, but things weren’t as flexible as in v2 or v3. Its use of AMMs took the trading industry by storm.

Uniswap V1 only allowed the swapping of ETH (the Ethereum token) and ERC20 tokens. If you wanted to trade a different crypto, you first had to convert it.

UniSwap V2 solved this bridging issue and introduced more liquidity pools, greatly reducing trading costs. The updated version offers a more user-friendly experience and takes on the ETH bridging issue by implementing ERC20-ERC20 pools. V2 also introduced a novel tool: Flash Swaps transactions. It basically eliminates the need for collateral, enabling access to higher volumes of liquidity without minimal funds. This type of transaction allows traders to borrow assets from a decentralized protocol, execute arbitrary logic, and then return these assets in a single Ethereum transaction. The second version of Uniswap introduced a protocol fee where traders have an active role in the DEX’s development — 0.05% of the 0.3% trading fee goes to exactly that.

Uniswap V3 introduced the concept of concentrated liquidity — providers can specify a price range for their liquidity. This allows for much higher capital efficiency and returns. With this new version, LPs can design their price curves according to their preferences to enhance liquidity. V1, V2, and V3 also present differences in the fees’ structure. While V1 had a flat trading fee of 0.3%, V2 reserves part of this value for platform developments. In V3, the trading fee varies — stablecoins have a fee of 0.05%, standard non-correlated pools are subject to 0.3%, and non-correlated pairs, to 1%. In the latest version, the protocol fee (available in V2) is off by default, but users can set it to a value between 10 and 25%.

The Polkadot ecosystem also offers a variety of different DEX solutions like HydraDX, Snekswap, Polkadex, Stellaswap, Zenlink, Polkaswap, and Solarbeam. We will dive into these in another article soon.

About Integritee

Integritee is the most scalable, privacy-enabling network with a Parachain on Kusama and Polkadot. Our SDK solution combines the security and trust of Polkadot, the scalability of second-layer Sidechains, and the confidentiality of Trusted Execution Environments (TEE), special-purpose hardware based on Intel Software Guard Extensions (SGX) technology inside which computations run securely, confidentially, and verifiably.

Community & Social Media:
Join Integritee on Discord | Telegram | Twitter Medium | Youtube LinkedIn | Website

L2 Sidechains | Trusted Off-chain Workers | Teeracle | Attesteer | Securitee | Incognitee

Integritee Network:
Governance | Explorer | Mainnet | Github

TEER on Exchanges:
Kraken | Gate | Basilisk

You Might Also Like

New image
Project UpdateJuly 02, 2024

Monthly Wrap-Up June 2024: Incognitee Bug Bounty Launch, Polkadot Treasury Proposal & More

New image
Project UpdateJune 26, 2024

Become a Collator Operator for Integritee Network!

New image
Project UpdateMay 02, 2024

MiCA & Other Crypto-Related Regulations: Striking the Right Balance

New image
Project UpdateApril 23, 2024

DEXs on Polkadot: Leveraging the Power of Substrate & Shared Security

New image
Project UpdateApril 16, 2024

Slot Auctions vs Coretime: What’s Changing for Polkadot Projects

New image
Project UpdateApril 03, 2024

Monthly Wrap-Up March 2024: Listing TEER on Basilisk, Attending Sub0 & Paseo Landing

New image
Project UpdateMarch 05, 2024

Monthly Wrap-Up February 2024: Crowdloan, Governance and Treasury

New image
Project UpdateFebruary 05, 2024

Monthly Wrap-Up January 2024: Launching the Incognitee Testnet, Winning a Hackernoon Award & Much More!

New image
Project UpdateFebruary 02, 2024

Polkadot Crowdloan: Campaign Kicks Off on February 7th!

New image
Project UpdateJanuary 30, 2024

2023 at Integritee: Product Releases, Partnerships, a Privacy Sidechain & Much More

New image
Project UpdateJanuary 19, 2024

OLI Systems Releases Research Paper about a DLT-Based Local Energy Market Model

New image
Project UpdateJanuary 05, 2024

Monthly Wrap-Up December 2023: New Products, Fresh Content & More

New image
Project UpdateJanuary 03, 2024

2023 Integritee Content: Giving Back to Our Community

New image
Product UpdateDecember 11, 2023

Unlocking Privacy in Transfers: The Power of Integritee’s Private Sidechain Model

New image
Project UpdateDecember 05, 2023

Monthly Wrap-Up November 2023: New Content, TEER Recover & Tech Updates

New image
Project UpdateNovember 06, 2023

Monthly Wrap-Up October 2023: Joining an Accelerator Program, Launching the New Website, Educational Content & More!

New image
Project UpdateOctober 06, 2023

Monthly Wrap-Up September 2023: Winning an Award, Talking at Sub0, Partnering with OVH & More!

New image
Project UpdateSeptember 27, 2023

OVH Releases Whitepaper on How Integritee Is Re-Inventing Blockchain Security & Confidentiality Using Intel SGX Technology & OVHcloud

New image
Project UpdateSeptember 04, 2023

Monthly Wrap-Up August 2023: Launching the Attesteer, Encointer’s PoP Badge & More

New image
Product UpdateAugust 30, 2023

Launching Integritee’s Attesteer

New image
Project UpdateAugust 08, 2023

Monthly Wrap-Up July 2023: Video Releases, Tech Updates & More

New image
Project UpdateJuly 06, 2023

Monthly Wrap-Up June 2023: Polkadot Decoded, New Add-Ons and More

New image
Project UpdateJune 06, 2023

Monthly Wrap-Up May 2023: Governance Platform Launch, New Environments and More

New image
NewsMay 09, 2023

Integritee Launches New Governance Platform with Polkassembly

New image
Project UpdateMay 04, 2023

Monthly Wrap-Up April 2023: Tech Upgrades, Partnerships & Upcoming News

New image
Project UpdateApril 06, 2023

Monthly Wrap-Up March 2023: Product Releases, a Privacy Sidechain & More

New image
Project UpdateApril 04, 2023

Securitee & enclaive Team Up to Offer Ready-To-Use TEE-Secured Solutions

New image
Product UpdateMarch 30, 2023

Securitee Launches Confidential Computing Platform to Protect Data in Use

New image
Product UpdateMarch 23, 2023

Introducing Integritee’s Teeracle: A Framework to Build TEE-Based Oracles

New image
Project UpdateMarch 21, 2023

A Privacy Sidechain for All Polkadot & Kusama Chains

New image
Project UpdateMarch 06, 2023

Monthly Wrap-Up February 2023: Launching Roadmap, Partnerships and More!

New image
NewsMarch 03, 2023

SDK v0.11.0: Increased Performance and Faster Processes

New image
NewsFebruary 21, 2023

OLI Systems Develops Innovative Energy Market Place by Building on Integritee

New image
Project UpdateFebruary 09, 2023

Integritee Network: Roadmap 2023

New image
Project UpdateFebruary 06, 2023

Monthly Wrap-Up January 2023: Slot Swap, Davos Touchdown and Much More

New image
Project UpdateJanuary 03, 2023

Community Updates: Discord, Twitter Raids & More

New image
Project UpdateJanuary 03, 2023

2022 at Integritee: Winning Parachains, Hosting Events, Integrating with Projects & Much More

New image
Project UpdateDecember 01, 2022

Monthly Wrap-Up November 2022: Lisbon Happenings, Bifrost Integration & More

New image
Project UpdateNovember 16, 2022

XCM Integration of Integritee and Bifrost Completed

New image
Project UpdateNovember 14, 2022

Integritee Welcomes Sergei Medvedev as New Advisory Board Member

New image
Project UpdateNovember 10, 2022

Monthly Wrap-Up October 2022: Travels, Interviews, Tech Updates & More

New image
Project UpdateOctober 06, 2022

Monthly Wrap-Up September 2022: Integritee SDK Release, Token2049 & More

New image
Project UpdateSeptember 20, 2022

Integritee & Securitee: Connecting the Dots

New image
Project UpdateSeptember 08, 2022

Integritee’s SDK: A New Era of Web3 Application Building

New image
Project UpdateSeptember 05, 2022

Monthly Wrap-Up August 2022

New image
Project UpdateAugust 30, 2022

Integritee Sidechain Performance Benchmark

New image
Project UpdateAugust 24, 2022

Integritee & Crust Team Up for Publicly Verifiable Decentralized Content Storage

New image
Project UpdateAugust 23, 2022

Integritee’s Polkadot Crowdloan

New image
Project UpdateAugust 03, 2022

Monthly Wrap-Up July 2022: Winning a Slot on Polkadot, Integrating with Karura & Much More

New image
Industry InsightsJuly 27, 2022

From Web 2.0 to Web3: A Step Forward

New image
Project UpdateJuly 18, 2022

Polkadot: The Next Step in Integritee’s Growth and Development

New image
Project UpdateJuly 13, 2022

Integritee Rewards Structure: Early Birds, Loyal Followers, Family, Friends, and More!

New image
Project UpdateJuly 11, 2022

The Integritee Polkadot Crowdloan Campaign Starts Today!

New image
Industry InsightsJuly 07, 2022

XCM Integration: What Is It and How Does It Work?

New image
Project UpdateJuly 05, 2022

Monthly Wrap-Up June 2022: Kraken listing, Talking at Polkadot Decoded & More!

New image
Project UpdateJuly 01, 2022

XCM integration of Integritee & Moonriver Completed

New image
Industry InsightsJune 20, 2022

Here’s What You Need to Know About XCM Integration on Polkadot

New image
Project UpdateJune 09, 2022

Integritee Completes 2 Key Milestones Towards Decentralization

New image
Project UpdateJune 03, 2022

Monthly Wrap-Up May 2022: Decentralization, International Events, Virtual Worlds & Much More

New image
Project UpdateMay 26, 2022

The Complete Guide to TEER Tokens

New image
Industry InsightsMay 16, 2022

How Integritee combines the benefits of Web2 and Web3 technologies