How DEXes work

What is a DEX? A decentralized exchange, or DEX, is a platform that enables users to trade cryptocurrencies directly with each other without the need for intermediaries. Unlike centralized exchanges, DEXes operate on blockchain technology, empowering users with full control over their funds and eliminating the need for a trusted third party to facilitate transactions.
Key Components of DEXes:
1. Smart Contracts: DEXes primarily rely on smart contracts, self-executing pieces of code that automatically facilitate and enforce transactions based on predefined rules. Smart contracts are typically deployed on blockchain platforms like Ethereum and provide the underlying infrastructure for order placement, trade execution, and settlement.
2. Liquidity Pools: DEXes utilize liquidity pools to ensure the availability of assets for trading. These pools consist of users' funds locked in smart contracts, which are used to facilitate trades. Liquidity providers (LPs) contribute their assets to the pool and earn fees for enabling trades on the platform.
3. Order Books vs. Automated Market Makers (AMMs): DEXes can either use traditional order book models or automated market makers. Order book models match buy and sell orders submitted by users, similar to centralized exchanges. On the other hand, AMMs rely on mathematical formulas and liquidity pools to determine asset prices based on supply and demand dynamics.
DEX Workflow:
1. User Wallet Integration: Users connect their decentralized wallets to the DEX platform, granting permission to interact with their funds securely.
2. Asset Selection and Trading Pair: Users choose the desired cryptocurrency pair they want to trade.
3. Placing Orders: Users can either create limit orders with specific price and quantity or opt for market orders to execute trades immediately at the best available price.
4. Trade Execution: The DEX matches orders from buyers and sellers, utilizing either the order book or AMM algorithms to determine the asset price and execute trades automatically.
5. Settlement: Once trades are executed, smart contracts handle the settlement process, ensuring secure and transparent transactions. The exchanged assets are directly transferred between users' wallets, without the need for a centralized clearinghouse.
Advantages of DEXes:
1. User Control and Privacy: DEXes enable users to retain complete control over their funds, eliminating the risk of centralized exchange hacks or custodial mishandling. Additionally, DEXes do not require users to disclose their personal information, enhancing privacy and reducing the risk of identity theft.
2. Transparency and Security: DEX transactions are recorded on the blockchain, providing immutable and transparent records of all trades. Moreover, the use of smart contracts eliminates the need to trust intermediaries, reducing the risk of manipulation or fraud.
3. Lower Fees: DEXes often offer lower trading fees compared to centralized exchanges. Additionally, users can become liquidity providers and earn a portion of the fees generated by trades.
4. Global Accessibility: DEXes are accessible to anyone with an internet connection, making them available to users worldwide. They enable cross-border transactions without the need for intermediaries or approval processes.

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Copyright © 2021, Zetly OU - All trademarks and copyrights belong to their respective owners.