What is a Decentralized Exchange (DEX)?

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I'm Donny. I'm a world traveler, investor, entrepreneur, and online marketing aficionado who has a big appetite to compete and disrupt big markets. I thrive on being able to create things that impact change, difficult challenges, and being able to add value in negative situations.

Are you interested in decentralized exchanges (DEXs)? We can help you learn about DEX and how to start cryptocurrency trading on a peer-to-peer (P2P) platform.

Key Takeaways
  • A DEX is a permissionless crypto company that uses P2P transactions.
  • DEXs have lower fees, trustless transactions and better security.
  • DEXs may experience issues with contract vulnerability, liquidity and trading volume.
  • Choose a DEX company if you want more control over your crypto funds.
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Decentralized Exchanges (DEXs) Definition

What is a DEX? A decentralized exchange (DEX) is a crypto exchange that does not maintain control of users’ funds. Transactions are P2P, and funds never go through an intermediary.

For example, if you purchase crypto through a decentralized company such as PancakeSwap, your currency goes directly to the buyer, and PancakeSwap never holds the funds in a third-party account.

How a Decentralized Exchange Works?

DEXs emerged in the cryptocurrency industry in 2014 when many users wanted a way to trade P2P. Before 2014, crypto companies were all centralized exchanges, which are companies that hold customer funds in a third-party account.

Traders were worried about hackers and internal theft, even with anti-money laundering (AML) and know-your-customer (KYC) measures.

DEX proved to be an effective way to trade with fewer money transfers. DEX companies also originated to respond to customer demand for lower fees.

DEX companies are more hands-off and can afford to charge less for transactions. The safety and affordability of DEXs soon popularized them within the crypto market.

Today, individual investors can post their crypto for sale on DEXs or search for new crypto to buy. Users can also trade between different coins, participate in staking or sometimes purchase non-fungible tokerns (NFTs).

DEXs are a great alternative to centralized exchanges, but they often require more experience in the crypto ecosystem, and more work falls on the traders.

Example of a Decentralized Exchange

How would someone use a DEX? Let’s take Uniswap as an example. Uniswap has a user base of over 4.5 million people, giving users plenty of trading options.

Like all DEXs, Uniswap works on a P2P system, so you can buy and sell crypto directly from other users. You can connect your bank account or trade crypto you already own.

Uniswap and similar exchanges, such as SushiSwap, Bancor, and PancakeSwap, usually offer other services. On Uniswap, you can trade NFTs, provide liquidity and earn fees, or build dApps on the Ethereum DeFi protocol.

Why would you buy crypto from an exchange such as Uniswap? DEXs allow you to have more control over your funds. Centralized exchanges, including Binance, hold your money in their account, where it incurs extra trading fees and could be at risk from hackers.

Types of Decentralized Exchanges

There are several different types of DEX companies. The list below may help you determine which one is right for you.

TypesFeatures
On-Chain Order BooksAllow you to lock your assets in a smart contract while still having price and order size flexibility
Off-Chain Order BooksHave order books on a centralized program outside of a distributed ledger. They can be subject to additional regulations.
Automated Market Makers (AMMs)Use algorithms to help traders buy and sell orders. AMMs are a type of DEX that pools liquidity from traders.
DEX AggregatorsUse algorithms to connect liquidity pools. They decrease slippage costs and help combat low liquidity.

Benefits of Decentralized Exchanges

Decentralized trading networks come with many benefits, including:

  • Reduced risk of hacks. Centralized third-party banks are susceptible to being hacked, but DEX have no central account.
  • Lower fees. DEXs let you control your trading, and they charge little to no fees.
  • Anonymity. DEXs have no KYC/AML or ID verification, which preserves your anonymity.
  • Privacy. DEXs allow you stay anonymous and withhold your private information.
  • Control of your crypto. You choose who to buy and sell from, and users always have control over their cryptocurrency wallets.
  • No counterparty risk. You aren’t at risk from other parties or from credit default.
  • Trustless transactions. You don’t have to place your trust in a third party such as Binance or the Ethereum blockchain.
  • Utility in the developing world. Easy-to-use DEXs are becoming popular in countries with little banking infrastructure.

To start trading, all users need is a device and an internet connection.

Disadvantages of Decentralized Exchanges

DEXs aren’t perfect, and they come with some disadvantages:

  • Scalability issues. Blockchain technology means DEXs struggle to handle ever-increasing transactions. Blockchain networks have a limited trading volume and have the potential to get overloaded.
  • Bad user experience. DEX companies typically have rudimentary interfaces and lower ease of use.
  • Smart contract vulnerability. These contracts can be vulnerable to hacks and issues with code.
  • Liquidity issues. Liquidity refers to how easily your crypto can translate to other currencies, and DEXs often struggle with high liquidity. Check if the company has good trading pairs and DEX aggregators.
  • Unvetted token listings. Be aware that any user can post a listing. Token sales may not be legitimate due to the low oversight of DEXs.
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What to Look for in a DEX

Consider these factors when choosing a DEX:

DEX Key Factors
  • Security. Check if the exchange offers private keys, which are passwords that prove ownership of a blockchain address. Decentralized finance is vulnerable to scams, so it’s essential to have tight security.
  • Liquidity. Will your crypto easily translate to other currencies? Look up the company’s liquidity and see if they have liquidity providers, aka investors who fund liquidity pools.
  • Accessibility. Consider if the interface is easy to use. It can make a big difference in your user experience.
  • Coins offered. Do you want a company that offers Bitcoin, Ethereum or other altcoins? See if the company has your favorite coins.
  • Cold wallet storage. Offline storage is crucial for safety.
  • Education tools. Seek out a crypto experience that’s a learning journey. Many companies, such as Coinbase, offer educational resources and helpful financial services and advice.

How to Open a Decentralized Exchange Account

Follow these easy steps to open a DEX account:

  1. Connect your wallet to your bank account.
  2. Explore the many coin options.
  3. Start selling, buying or trading crypto.

Should I Use a Decentralized Exchange?

Decentralized exchanges are ideal for traders who want more privacy, anonymity, lower fees and more control over their crypto assets.

With many kinds of DEXs on the market today, there’s a DEX for everyone’s unique needs. Consider your experience level before committing to a DEX company.

Due to the higher level of responsibility required, traders generally get into DEXs after gaining crypto trading experience.

However, newer, user-friendly platforms, such as Uniswap, are now attracting first-time users. After reviewing the information in this article, you should be able to make an informed decision.

Take action today, and sign up to use a decentralized crypto exchange!

DEX FAQs

Learn more about DEXs by reviewing the following questions:

Why should I use a decentralized exchange?

DEXs help customers transfer crypto assets P2P. You should use a DEX if you want high anonymity and lower fees.

What is the difference between a centralized and decentralized exchange?

A centralized exchange holds your crypto funds and is often easier to use. A DEX gives you more control and lets you complete transactions directly with other users.

How do DEX fees work?

Most crypto companies charge you a percent every time you buy, sell or trade cryptocurrencies.

DEX companies charge lower fees, and many companies, such as dYdX and KINE, have no transaction fees whatsoever.

Are decentralized exchanges legal?

Yes, decentralized crypto exchanges are legal. A central authority doesn’t regulate the companies like in a centralized business, but they use smart contracts for security instead.

How do decentralized exchanges make money?

DEXs make money through transaction and trading fees. Many of them also sell unique altcoins and stablecoins.

LocalBitcoins

Buy and sell bitcoins near you. Fast, easy and private. Join the most trusted Bitcoin marketplace!

We earn a commission if you make a trade, at no additional cost to you.

I'm Donny. I'm a world traveler, investor, entrepreneur, and online marketing aficionado who has a big appetite to compete and disrupt big markets. I thrive on being able to create things that impact change, difficult challenges, and being able to add value in negative situations.

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