Explained by Mercuryo partner 1inch Network.
When cryptocurrency was only starting to gain ground, there was only one option to exchange these assets. Whether you needed to trade some BTC to ETH or invest in a couple of altcoins using your hard-earned fiat, you would go to the centralized exchange such as Binance or others, deposit your funds, and seal the deal.
And it did work quite well until hackers started targeting these centralized exchanges and governments started regulating their work. And once users’ safety and privacy went down the drain, a legitimate question arose. Why use centralized exchanges? Shouldn’t we trade our coins with other people directly?
That’s how decentralized exchanges (DEXs) came along. At the beginning of their journey, they weren’t too user-friendly and seriously lacked liquidity. After a while, the technology behind DEXs became more advanced, and now it is an independent and very trendy industry.
Types of DEXs
Decentralized exchanges are dApps that allow anyone to trade their crypto do so peer-to-peer without depositing their funds to the exchange. DEXs offer an entirely different model of trading based on smart contract execution.
There are three main types of DEXs: on-chain and off-chain order books and automated market makers.
On-chain order books mean that everything happens and is recorded on a blockchain. That’s why these DEXs depend on nodes that keep the record of the orders and rely on miners confirming transactions.
Off-chain order books are not entirely decentralized as the transaction records are hosted via a centralized entity. 0x protocol is a classic example of the off-chain order book DEXs that uses relayers for dealing with the orders. This model suggests that all the matching happens off-chain, and the only action executed on-chain is the finalization of a transaction.
Automated market makers started trending in 2020 following the DeFi hype. They move away from the concept of order books whatsoever and use an algorithmic approach instead. Powered by smart contracts, AMMs create liquidity pools and process the trades automatically according to a predefined set of parameters. A lot of popular DEXs, including Uniswap, SushiSwap, and Bancor, use the AMM model.
Realistically, every type of decentralized exchange has its pros and cons, but liquidity and security are what matters the most at the end of the day.
Perks of Using DEXs
Apart from the obvious advantage of having full custody of your assets, DEXs offer a few more bonuses to their users.
Freedom and Privacy
While all the major crypto exchanges require their users to pass the KYC procedure, which can be pretty tricky and lengthy, you don’t need to share any personal info such as your photo or ID to trade on a decentralized exchange.
Besides, since the whole trading process is done peer-to-peer, it doesn’t matter what passport you are holding. Mainstream centralized exchanges don’t operate in all the countries, a deal-breaker for the citizens of the restricted zones. DEXs, unless they are partially centralized, aren’t regulated and operate globally.
Variety of Tokens
Centralized exchanges have a strict token listing policy and mainly offer the most in-demand coins to trade. So if you’re looking for something slightly more exotic, you’ll have to look elsewhere, for instance, on a decentralized exchange.
If there’s a supply and demand, you can trade it on DEX. Create a new token yourself, find a friend who wants to swap it for something else, and use a DEX to finalize the exchange.
Downsides of DEXs
So why don’t we all switch to DEXs then? Although decentralized exchanges improved a lot in the past few years, there are some cons to keep in mind.
If you are new to the cryptocurrency space, trading on a decentralized exchange is probably not the best idea:
- DEXs don’t usually work with fiat, so buying crypto with your credit or debit card won’t be an option. Not anymore!
- If you don’t do your research about crypto wallets, trading on DEX will be a real challenge, and there’s no customer service team to help you out.
- In case you lose your seed phrase, you’ll lose your funds too.
Centralized exchanges, in turn, offer a lot more comprehensive user experience.
Liquidity and trading volume are the main pain points of decentralized exchanges. After the DeFi boom, those issues did improve a little, but liquidity and trading volumes are still incomparable to ones offered by centralized exchanges. You might experience difficulties finding trading pairs that you need, and if you do, the price can also disappoint you.
One would think that trading on DEXs should be cheaper than using mainstream CEXs. However, that’s not always the case. On-chain order books and network congestion result in higher fees. And since Ethereum powers the majority of DEXs, network fees are not the lowest. Another thing to keep in mind is that different DEXs might offer different fees – exchanges with more complex processing logic require more gas which increases the expenses.
Aggregation in Action
All the above might sound a bit complicated, and it actually is a bit complicated – especially for inexperienced users who have just entered the crypto space or thinking about it.
Figuring out which DEX better suits one’s needs and comparing swap rates, which could differ significantly across exchanges, is a time consuming and difficult task. Therefore, the best option for users who want to save time and – on many occasions, money, – is to use a DEX aggregator, such as 1inch.
The 1inch Aggregation Protocol searches deals across multiple DEXes, offering users better rates than any individual exchange. To get users the best rates, deals are split across multiple exchanges, as well as across different market depths withing the same exchange. The protocol also enables users to save on gas costs.
In addition, the 1inch Aggregation Protocol facilitates access to the deepest liquidity, with over 50+ liquidity sources on Ethereum, 20+ liquidity sources on Binance Smart Chain and 7+ liquidity sources on Polygon. In just two years the 1inch DEX aggregator surpassed $42B in overall volume!