A decentralized exchange or DEX is the technological evolution of a traditional exchange. In a decentralized exchange, all its operation is transferred to the blockchain, executing on powerful smarts contracts, with which everything is managed within the platform.
Either if you are new to the world of cryptocurrencies and blockchain, or on the contrary, you already have knowledge about it, it is very likely that you have heard about exchanges. These are digital exchanges where you can exchange cryptocurrencies and tokens for fiat money or for other cryptocurrencies. And where the value of cryptocurrencies is determined by the supply and demand of crypto assets in the market.
But what are decentralized exchanges (DEX)? There is much talk about this type of exchange today, especially for the level of security they offer the user, and even anonymity.
Decentralized exchanges, also known as DEX, are digital platforms that work like traditional exchanges. But, unlike traditional exchanges, a smart contract operates at the center of the service. This eliminates intermediaries to a great extent, making them more secure and transparent. Simply put, a decentralized exchange, or DEX, is a cryptocurrency exchange operated by smart contracts.
This means that the trust and management of the funds does not fall on a central figure. But on the contrary, exchange users maintain control of their assets at all times. A feature that adds a high level of security, privacy and even anonymity, when operating in this type of exchange houses.
But how do we get from traditional exchanges or decentralized exchanges? What other advantages do DEX offer us? Well, let’s take a look at the history behind these decentralized exchanges.
Origin of decentralized exchanges
Cryptocurrency exchanges have evolved a lot since the creation of the first of these platforms. In the beginning, exchanges like Mt Gox. they followed a centralized management and interaction model. That is, the exchange controlled the funds we have in it. And to perform operations it was necessary to log in. This obviously ends the decentralization of cryptocurrencies and creates serious security problems, as the Mt Gox hack showed us.
Decentralized exchanges were born to deal with this and other problems that centralized exchanges present. Of the first platforms of this type were OmiseGo and BitShares that began to be developed in 2013. Each of them with different functions and capabilities, but with the same objective: to start the revolution of decentralized exchanges. But getting to that point has required an evolution over time that we will describe below.
Types of exchanges
Now, the evolution of exchanges has created three types of exchanges or generations, well differentiated. These are:
- First generation: Despite being a relatively new concept, decentralized exchanges already have different versions. On the one hand we have the traditional exchanges, these are centralized, you must send your cryptocurrencies losing absolute control of them and blindly trusting the good work of the platform. We can call these exchanges centralized, but also first generation.
- Second generation: On the other hand we find the most basic decentralized exchanges, the second generation. These change the central piece for a smart contract, which is responsible for making the exchanges. As a smart contract, everyone can see how it works. However, in these smart contracts you must send your cryptocurrencies, losing possession of them during the time you want to make the exchanges.
- Third generation: A new generation of decentralized exchanges improve this last point, allowing you not to need to send your cryptocurrencies anywhere, despite being able to open exchange orders with them. We call them third generation exchanges. In the same way, they act through a Smart contract in the epicenter of the tool, but it allows you to keep the cryptocurrencies in your wallet at all times, so if those tokens give you dividends, or voting options in a DAO, you can do so until last millisecond of the exchange.
Blockchain technologies for DEX
Although Ethereum is the most used platform for this type of development, due to the large number of projects (tokens and DApps) that are being developed on it, there are other blockchains that also allow this, including Bitcoin through the Counterparty project. Some other blockchains that allow you to create decentralized trading platforms are: Stellar, Komodo, Waves, BitShares, NEO or Ardor among others.
Advantages of DEX
Everyone can see in a transparent way how the service works, how it will act in any situation and see in real time what happens within it, without manipulation.
Protection and security
Hundreds of millions of euros are stolen from centralized exchanges every year. In 2018 alone, more than 1 billion euros were stolen from centralized exchanges.
Smart contracts can be implemented in DEXs as a protection against scams and fraud. Thus, when establishing a contract with certain conditions to be met, the parties involved in the exchange must obey these conditions for the operation to be executed. In the event of non-compliance with any or all of the conditions, the contract expires and is not executed. Best of all, these contracts, once scheduled, are executed automatically and decentrally.
On the other hand, DEXs work through a network of interconnected computers, much like a blockchain network. So they have high protection against hacks or computer attacks that threaten the integrity of user funds.
However, decentralized exchanges (especially second generation ones) can also suffer theft, since all funds are held by a smart contract that may contain flaws, such as the famous multimillionaire theft The DAO.
A high degree of anonymity is another advantage they can offer. This is because a decentralized exchange (DEX) only uses addresses to carry out transactions and exchanges. Without requiring users to provide personal data and information.
Another advantage of decentralized exchanges is their robustness and solidity. The chances of a DEX system crash are almost nil; so users will not have to worry about this problem. This is because DEXs do not operate with a single server, as is the case with centralized exchanges.
Disadvantages or disadvantages of DEX
At first, without knowledge, the DEX platform can seem confusing and difficult to operate. Therefore, it is almost always necessary for the guidance or instruction of an expert user to understand them and begin to operate in them.
A decentralized exchange (DEX) does not serve to make exchanges between cryptocurrencies of different blockchains. Since Ethereum is the network with the most tokens, the most famous decentralized exchanges are from this network. But for example you cannot exchange Bitcoin for Ethereum, only Ethereum tokens for other Ethereum tokens.
Types of orders
The types of orders that can be placed in a decentralized exchange are very limited, being able to place only Limit and Market type orders.
As in DEX exchange operations occur within the same blockchain, its process is much slower than in a centralized exchange. So a decentralized exchange cannot handle high frequency.
The most important thing about an exchange platform is liquidity, which in turn generates low spreads. A decentralized exchange (DEX), due to its null manipulation capacity, usually has little liquidity, generating in turn little traction that turns back into little liquidity and high spreads. Something that scares away any user.