DEX meaning crypto stands for Decentralized Exchanges. These are trading venues where no intermediaries are required.
How a centralized exchange works
With your typical centralized exchange, you deposit your money – either fiat or cryptocurrency. When you deposit crypto, you give up control of it. Not from a usability standpoint, as you can still trade it or withdraw it, but from a technical standpoint: you cannot spend it on the blockchain.
This means that you no longer hold possession of the private keys to the funds, hence when you withdraw, you ask the exchange to sign a transaction on your behalf. When you’re trading, transactions don’t occur on-chain – instead, the exchange allocates balances to users in its own database.
Typically, the workflow is greatly streamlined and automated because the slow speeds of blockchains don’t impede trading, and everything occurs in a single entity’s system. Cryptocurrencies are easier to buy and sell, and you have more tools available to you.
However, this comes with a risk as you would have to trust the exchange with your money. There are possibilities of the exchange getting hacked, or people running off with the funds.
How a decentralized exchange works
Now that you know DEX meaning crypto, let us explore how a decentralized exchange works. In contrast to centralized exchanges, orders are executed on-chain (with smart contracts) on decentralized exchanges and users do not sacrifice custody of their funds at any point.
On-chain order books
In some decentralized exchanges, everything is done on-chain (we’ll talk about hybridized approaches shortly). Every order (as well as alteration and cancellation) is written to the blockchain. This is perhaps the most transparent approach, as you’re not trusting a third party to relay the orders to you, and there’s no way to obfuscate them.
Unfortunately, it’s also the most impractical. Since you’re asking every node on the network to record the order forever, you end up paying a fee. You need to wait until a miner adds your message to the blockchain, meaning the experience can be cumbersome, too.
Off-chain order books
Off-chain order book DEXs are still decentralized in some regards, but they’re admittedly more centralized than the previous entry. Instead of every order being posted to the blockchain, they’re hosted somewhere.
You could have a centralized entity completely in charge of the order book. If that entity is malicious, then they could game the markets to an extent (i.e., by front running or misrepresenting orders). However, you would still benefit from non-custodial storage.
The 0x protocol for ERC-20 and other tokens deployed on the ETHereum blockchain is a good example of this. Rather than act as a singular DEX, it provides a framework for parties known as “relayers” to manage off-chain order books. Leveraging 0x smart contracts and some other tools, hosts can tap into a combined liquidity pool and relay orders between users. The trade is only executed on-chain once the parties are matched.
These approaches are superior from a usability perspective than those that rely on on-chain order books. They don’t face the same constraints in terms of speed, as they don’t use the blockchain as much. Still, the trade must be settled on it, so the off-chain order book model is still inferior to centralized exchanges in terms of speed.
Automated Market Makers (AMM)
AMMs don't require makers or takers. It requires only users, game theory, and computer coding. They work by stringing togETHer a bunch of smart contracts and clever incentives to entice user participation.
Pros of DEXs
No KYC is needed for DEXs. KYC/AML (Know Your Customer and Anti-Money Laundering) compliance is the norm for many exchanges. For regulatory reasons, individuals must often submit identity documentation and proof of address. Since DEXs are permissionless, you do not have to worry about not having your valid documents on hand.
Furthermore, the appeal of decentralized cryptocurrency exchanges is that they don’t hold customers’ funds. As such, even catastrophic breaches like the 2014 Mt. Gox hack won’t put users’ funds at risk or expose any sensitive personal information.
Cons of DEXs
Realistically, DEXs aren’t nearly as user-friendly as traditional exchanges. Centralized platforms offer real-time trades that are unaffected by block times. For newcomers unfamiliar with non-custodial cryptocurrency wallets, CEXs provide a more forgiving experience. If you forget your password, you can simply reset it.
Although the volume traded on CEXs dwarfs that of DEXs, more importantly, CEXs tend to have greater liquidity. Liquidity is a measure of how easily you can buy or sell assets at a reasonable price. In a highly liquid market, bids and asks have little difference in price, signifying high competition between buyers and sellers. In an illiquid market, you’ll have a more difficult time finding someone that wants to trade the asset for a reasonable price.
In Conclusion
DEX meaning crypto stands for Decentralized Exchanges. In this article, we have gone through how DEXs work, as well as its pros and cons.
