How Does a Decentralized Exchange Work

Since the early stages of Bitcoin, exchanges have been a key part of connecting people who want to buy or sell cryptocurrencies. In this area, centralized exchanges have been the norm for a long time. A good example is Binance which is one of the largest centralized exchanges with over 29 million users.

With advancement in technology more tools for decentralized trading are becoming available as well as more decentralized exchanges are being formed.

In this article, we will explain a decentralized exchange, its benefits, and how a decentralized cryptocurrency exchange works.

How Does It work?

A peer-to-peer market where crypto traders buy and sell directly is called a decentralized exchange, or DEX. One of the most important things that DEXs offer is help people make financial transactions that do not involve banks, brokers, payment processors, or any third party.

Decentralized exchanges are simply a set of smart contracts that establish the prices of various cryptocurrencies against each other using an algorithm in which investors lock funds in exchange for interest-like rewards to facilitate trades.

While transactions on centralized exchanges are recorded on an internal database, DEX transactions are settled directly on the blockchain.

Some popular examples of DEXs are UniSwap, Defi Swap, PancakeSwap, etc.

Benefits of a DEX

1. No Sign-Up Hassle and KYC Requirements

You don’t need to go through the lengthy steps of user registration and KYC (Know Your Customer). Since DEXs don’t require users to provide authorization or documentation before trading, nobody verifies their identity. A cryptocurrency wallet is all that is required.

2. Trading for Unlisted Token

In many cases a token that is wanted may not be listed on a centralized exchange for many reasons. If this occurs, DEXs make it possible to trade these tokens provided sufficient demand and supply is available for the tokens.

3. Increased Reliability and Safety

Trading on a centralized exchange incurs the risk of a security breach or hacking. In the past, centralized exchanges have been targeted by cybercriminals. In 2016, Bitfinex, one of Hong-kong’s largest centralized exchanges, was hacked, and more than 120k Bitcoins were stolen from users wallets. Permission-less decentralized exchanges can handle this problem significant

DEXs also come with challenges; despite this, they are still considered more reliable because users continue to act as the custodians of their digital assets.

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