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The Decentralized Exchange Landscape

DEXs allow crypto investors to hold their keys while trading by using liquidity solutions from order books to liquidity pools — and more.

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Summary

Although centralized exchanges (CEXs) currently dominate cryptocurrency trading activity, decentralized exchanges (DEXs) are growing in popularity. DEXs facilitate peer-to-peer trading by relying on automated smart contracts to execute trades without an intermediary. However, not all DEXs employ the same underlying infrastructure. While some retain conventional order book models, others use emergent liquidity protocols. In addition to exchange and liquidity protocols, developers are building new aggregation tools to address the disjointed liquidity that’s inherent in decentralized exchanges.

Decentralized Exchanges vs. Centralized Exchanges

Cryptocurrency exchanges provide a crucial source of liquidity to the global cryptocurrency market, facilitating billions of dollars in trading volume on a daily basis. As this market expands, leading exchange platforms continue to scale in response to the demand for digital assets, offering asset custody, new trading features and functionality, and access to an ever-growing number of digital assets.

With disintermediation as a core philosophy of the blockchain community, decentralized exchanges — or DEXs — have gained in popularity alongside traditional centralized exchanges (CEXs). Decentralized exchanges take a different approach to buying and selling digital assets: They operate without an intermediary organization for clearing transactions, relying instead on self-executing smart contracts to facilitate trading. This dynamic enables instantaneous trades, often at a lower cost than on centralized crypto exchanges.

In the absence of intermediaries, DEXs take on a non-custodial framework. This means that you retain custody of your cryptocurrency and are responsible for managing your wallets and private keys. Holding your private keys is considered a boon to users who want to maintain complete control of their assets. However, this comes with the risk that your keys could get lost, stolen, or destroyed; or in the unlikely possibility that you become incapacitated or pass away suddenly, if no one knows your password, your keys can’t be accessed. The lack of an intermediary also means that most DEXs have limited counterparty risk and are not required to follow Know-Your-Customer (KYC) or Anti-Money-Laundering (AML) regulatory standards.

The emerging DEX market encompasses distinct segments. Each platform uses various implementations of order books, liquidity pools, or other decentralized finance (DeFi) mechanisms like aggregation tools to offer novel and experimental financial instruments.

Decentralized Exchanges (Order Book)

There are multiple generations to decentralized crypto exchanges and DeFi products. The first generation of decentralized exchanges use order books, similar to conventional centralized exchanges. These order books compile a record of all open buy and sell orders for a particular asset. The spread between these prices determines the depth of the order book and the prevailing market price. On DEXs with order books, this information is often held on-chain during trades, while your funds remain off-chain in your wallet. Many DEXs specialize in a particular financial instrument that is executed in a decentralized manner.

  • dYdX: The dYdX protocol allows users to access derivative products in a decentralized environment. dYdX also supports peer-to-peer borrowing, which means you can earn passive income while your assets are held on the exchange.

  • Nash Exchange: The Nash exchange aims to match the speed and functionality of conventional exchanges with its proprietary matching engine while using a decentralized framework. By efficiently matching buy and sell orders, NASH improves on conventional order books by maximizing the number of potential transactions.

  • Tomo DEX: The Tomo DEX stores and matches all orders on-chain but moves funds off-chain to user wallets instantly, improving the speed of every trade. The platform operates over 150 nodes and charges no withdrawal or deposit fees. The use of an extensive, distributed network of nodes facilitates security on the Tomo DEX.

  • ViteX: The ViteX exchange matches transactions through smart contracts that run on-chain. The platform also completes order combinations and stores order books on-chain, along with exchange fee redemption. As such, all exchange activity is public, minimizing the risk of record tampering.

  • Loopring Exchange: The Loopring platform features an order-book based DEX protocol known as zk-Rollups, which validates transactions using zk-SNARKs technology. Validity proofs update and verify the DEX asset holdings, make transactions more private, and improve the scalability of the Ethereum network.

  • Binance DEX: The decentralized iteration of the centralized Binance platform, Binance DEX operates through a web-based application programming interface (API) that uses a similar user interface to Binance.com. The exchange offers the same functionality as a typical DEX, but also integrates TradingView charts with technical indicators. By bringing conventional tools to a DEX, Binance eases the transition to unfamiliar infrastructure.

  • DDEX: The DDEX exchange facilitates decentralized margin trading. Margin trading occurs when users borrow funds to amplify their potential returns. Margin trading may carry a high degree of risk as market downturns amplify losses of borrowed money.

Decentralized Exchanges (Swaps)

The next generation of decentralized exchanges does not use order books to facilitate trades or set prices. Instead, these platforms typically employ liquidity pool protocols to determine asset pricing. Peer-to-peer in nature, these exchanges execute trades between users’ wallets instantly — a process some refer to as a swap. The DEXs in this category are ranked in total value locked (TVL), or the value of assets held in the protocol's smart contracts.

  • Uniswap: Users of the Uniswap platform can swap any two Ethereum-built assets seamlessly atop an underlying liquidity pool. These highly accessible liquidity pools ensure that Uniswap remains permissionless and trustless, which democratizes lending and borrowing on the platform.

  • Curve: Similar to Uniswap, Curve is a decentralized exchange that utilizes a liquidity pool. However, Curve specifically caters to stablecoin trading, allowing users to trade between them with low slippage and fees — all through the use of an algorithm that optimizes trading pairs.

  • SushiSwap: SushiSwap emulates Uniswap, except that it started by offering liquidity providers a token known as SUSHI (which Uniswap later also offered with its UNI token). On Uniswap, the trading fee is 0.3%, but SushiSwap allocates the 0.3% differently, distributing 0.05% in the form of SUSHI tokens.

  • DODO: Like others in this segment, DODO is a liquidity protocol. However, the DODO platform employs its Proactive Market Maker (PMM) algorithm to provide adequate liquidity.

  • Balancer: Balancer builds on the concept of Uniswap but has more liquidity pool flexibility. While Uniswap has liquidity pools of equally weighted token pairs, Balancer allows for pools with different ratios (80/20 or 70/30 DAI/ETH for example). Although a Balancer pool could be a mere token pair, it also allows for liquidity pools with as many as eight different assets.

  • Bancor: The Bancor exchange model does not require a second party to execute a trade. Instead, you can exchange your ERC-20 tokens for Bancor’s native “smart” Bancor Network Token (BNT). You can then exchange these for other ERC-20 tokens on the platform.

  • Kyber: The Kyber protocol operates as a stack of smart contracts that run on any blockchain, not just Ethereum. Like other exchanges operating without an order book, Kyber utilizes liquidity pools to facilitate peer-to-peer swaps.

  • Gnosis: The Gnosis protocol pools liquidity through a unique mechanism called ring trades, which function as order settlements that share liquidity across all orders, not just a single trading pair. The protocol is well-suited to trading prediction-market tokens and other tokenized assets.

Decentralized Exchange Aggregators

Decentralized exchanges use a number of different protocols and mechanisms. Although this dynamic results in higher security and autonomy, it also results in disjointed liquidity across platforms. This lack of liquidity can be a deterrent for institutional investors or wealthy independent traders who want to purchase a select crypto asset in large volumes. To address this, DEX aggregators have developed tools to deepen asset liquidity pools across centralized and decentralized crypto exchanges.

  • 1inch Exchange: The 1inch platform aggregates liquidity from different DEXs to minimize slippage on large orders. Slippage occurs when there is insufficient liquidity on one platform, resulting in a buyer paying more to buy an asset than was expected. By eliminating slippage, capital is made available to a trader for the best price possible.

  • DeversiFi: The DiversiFi protocol aggregates liquidity across both centralized and decentralized exchanges to provide increased liquidity. DeversiFi also uses StarkWare’s batching technology to settle 9,000+ trades per second via user interface or API.

Decentralized Exchange Evolution

Although centralized exchanges account for the vast majority of market activity, since they offer security, regulatory oversight, and oftentimes insurance, the growth of DeFi has created room for the development of decentralized crypto exchange protocols and aggregation tools. Platforms like Uniswap, Curve, and Balancer display the potential for simple, user-friendly platforms that rely on liquidity protocols rather than order books. As the DEX market matures, the proliferation of new protocols and supporting mechanisms will likely only accelerate.

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