Decentralized exchanges (DEX)
Decentralized exchanges or DEX in short, are an important part of Decentralized Finance (DeFi) by enabling cryptocurrency trading.
DEXs are thus decentralized exchange platforms and enable (easy) trading of cryptocurrencies without the need for an intermediary.
Unlike a traditional centralized exchange (e.g., New York Stock Exchange, NYSE), a DEX uses algorithms and smart contracts as a substitute for central authority. Thus, DEX customers rely on a clean code and algorithm rather than a central authority or intermediary.
Typically, DEXs utilize an Automated Market Maker (AMM) design by using liquidity pools. Thanks to these liquidity pools, traders (buyers, sellers) are enabled to exchange tokens at any time and very quickly, instead of waiting for a specific order to be fulfilled and executed.
Liquidity pools are complex constructs and need to be very well designed and implemented (including incentives for liquidity providers). The big added value is that they allow for easy and fast trading of tokens within a decentralized exchange (DEX).
Unlike traditional exchanges, DEXs offer users privacy without having to go through a formal KYC process.
No central authority needs to manually validate and process transactions, which naturally increases efficiency and usually significantly reduces fees for an exchange compared to traditional banking.
Although a DEX offers many possibilities and advantages compared to classic exchanges, there are also some critical points and risks which should not be ignored.
Among others, these are partially low liquidity, the restriction to trading cryptocurrencies, as well as the complexity of the necessary software.
A well know example of a DEX is MakerDAO.