Decentralised Exchanges – The ‘Wild West’ of the crypto world

Decentralised exchanges do not entail a sign-up process, or a KYC application, you do not even need an email address to interact with these platforms – all you need is a smart contract compatible wallet, a smartphone and a working internet connection.

Could you imagine a financial eco-system that offers banking instruments without the intervention of intermediaries such as brokerages, exchanges or banks by employing digital smart contracts on a blockchain? – that is Decentralised Finance (DeFi) for you.

If you have been following the crypto scene lately, you would not have missed the exponential rise and notoriety of the decentralised exchanges (DEX) that operate within the DeFi framework.

Unlike the conventional ‘centralised exchanges’ DEXs allow for direct peer-to-peer (P2P) cryptocurrency transactions to take place online securely and without the need for an intermediary.

Although this unregulated space dubbed the ‘Crypto’s Wild West’ is getting a lot of flak lately, many pundits believe that it has the potential to revolutionise the banking and finance sector as a whole.

In this article:

Centralised vs Decentralised

How do DEXs work?

Using DEXs

Regulators en route

Centralised vs decentralised

In conventional terms, cryptocurrencies are traded on two types of exchanges – centralised and decentralised.

Although trading of the popular cryptocurrencies such as BTC primarily occurs on centralised exchanges such as eToro, Binance, Coinbase, etc, several newly issued tokens trade exclusively only on the decentralised platforms.

Centralised exchanges are developed and managed by a specific company or an individual, which have complete control over its operations and independently make decisions that are important for the development of the service.

DEXs, however, are aimed at solving problems that are inherent in centralised exchanges, they create p2p markets directly on the blockchain, which allows traders to independently store and operate funds banking on its distributed architecture and the lack of a single control centre.

These exchanges are developed in such a way that allows users to retain ownership of their cryptocurrencies and private keys – giving more control to the user.

Moreover, given that DEXs use smart contracts to facilitate trade, they require far less supervision compared to centralised platforms.

While some people still find it easier to trust a third party with their private keys, centralised infrastructures have a single point of failure making them vulnerable to a total shutdown through disruptions and hacking attacks.

Theoretically, decentralised environments are less susceptible to attacks, however, DEX-related hacks and scams have been on the rise, making up 54% of major crypto fraud volume in 2021, compared to 3% for all of 2020 – mostly targeting novice investors due to their unregulated nature.

How do DEXs work?

Unlike centralised exchanges, DEXs do not allow for exchanges between fiat and cryptocurrencies.

Instead, they exclusively trade cryptocurrency tokens for other cryptocurrency tokens.

Simply put, DEX’s are a “set of smart contracts”.

Nick Szabo, who coined the term in the early 1990s, used it to refer to “a set of promises, specified in digital form, including protocols within which the parties perform on these promises” – which still holds in the modern context.

The core technology backing the present DeFi ecosystem is liquidity pools ­–   a collection of crypto assets locked within a smart contract, which can be used for exchanges, loans and other applications.

The most popular DEXs such as Uniswap and Sushiswap work on the Ethereum blockchain and are part of the growing suite of decentralised finance (DeFi) tools, which make a vast range of financial services available directly from the user’s crypto wallet.

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.

Using DEXs

Decentralised exchanges do not entail a sign-up process, or a KYC application, you do not even need an email address to interact with these platforms – all you need is a smart contract compatible wallet, a smartphone and a working internet connection.

The first step is to decide which network a user wants to use, as each trade will incur a transaction fee.

Largest DEX is Uniswap, which was built in 2018 on top of the Ethereum blockchain, the world’s second-largest cryptocurrency project by market capitalisation.

The next one is to choose a wallet compatible with the selected network and fund it with its native token (usually ETH).

With Uniswap, you will need to make sure you already have an ERC-20 supported wallet setup such as MetaMask, WalletConnect, Coinbase wallet, Portis, or Fortmatic … and voila you are ready to start trading!

Regulators en route

Nowadays, DEX has become the most important infrastructure of DeFi and is a leader in terms of Total Value Locked (TVL) and the number of projects.

However, the unregulated nature of these markets and its notoriety for attracting a ‘mixed bag’ of people who have capitalised on its decentralised architecture to fraud investors.

Consequently, the regulators are fast approaching, a Senate committee focused on fintech has recommended a complete overhaul of the regulatory process in Australia for the digital currency industry.

In its report, the committee recommended several changes that will impact digital currency exchanges, decentralised finance (DeFi), decentralised autonomous organisations (DAOs), block reward miners, traders and other stakeholders in the industry.

However, DEX and the wider DeFi ecosystem has the potential to disrupt all conventions of banking and finance, and will likely emerge from its budding challenges to be a significant player in the future of the internet which will be powered by Web3.

Author: Traciwininger

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