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The world of finance is experiencing a shift that is cutting across all spheres. The rise of cryptocurrency brought about the development of more secure and advanced financial transaction systems. DEXs, known in full as decentralized exchanges, are platforms where transactions can be carried out without needing a middleman.
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Understanding Decentralized Exchanges: A Guide to How DEXs Work
With the introduction of decentralized exchanges, the need for mediators or intermediaries during the execution of crypto transactions is eliminated. Users can trade directly with one another through the p2p (Peer-to-peer trading). The way decentralized exchanges work is that transactions are executed and managed by already written sets of code commonly referred to as smart contracts. These smart contracts, once written, will then guide transactions without the need for an intermediary, making the whole process transparent and totally decentralized.
To ensure the security of assets and to achieve decentralization, DEXs have private keys for every user. These keys are not known to anyone else, and only with these keys can access to a wallet be gained. In a situation where private keys are lost, assets may be lost forever.
What are Decentralized Exchanges?
Decentralized exchanges are platforms, or can be referred to as cryptocurrency marketplaces, totally dependent on smart contracts, where traders execute financial transactions without the aid of a mediator.
Before the advent of decentralized exchanges, centralized exchanges had always been on the scene. However, the difference between the two is that centralized exchanges are controlled and regulated by financial institutions like banks and other financial houses. The aim of these financial institutions is mainly to get profit, so they can often manipulate the marketplace.
Decentralized exchanges allow traders to be entirely in charge of their assets. With the issuance of private keys, traders can directly interact with the smart contract powering the DEX they are using and run transactions independently. This way, traders will be entirely in charge of their loss or gain.
How Decentralized Exchanges Work
Unlike centralized exchanges, DEXs are powered by smart contracts that have their foundation in blockchains. These smart contracts run on blockchain networks like ethereum blockchain, and then traders execute their trades through these smart contracts stored on blockchain. Traders are usually charged a certain fee called transaction fee by the blockchain network alongside the trading fee.
We have three main types of DEX currently, and they all operate with the idea of smart contracts being the working mechanism. We have DEX aggregators, automated market makers and order books DEXs.
Top Crypto DEXs in 2023
Benefits of Using a DEX
Using private keys and eliminating a middleman in the execution of transactions makes decentralized exchanges safer than centralized exchanges.
- Decrease in Counterparty Challenge
The use of smart contracts helps to regulate parties involved in transactions. The already programmed contract will not allow for false execution and will ensure that necessary conditions are met by both parties involved in the transaction before execution.
The user's identity is not revealed when making a transaction on DEX. This further enhances security off-platform, particularly in the case of huge transactions.
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Although DEXs have better security and transparent transactions than centralized exchanges, it is important to make use of DEXs that are licensed and have good reputation. You can explore the list of top DEXs provided in this article and, alongside your personal research, decide which one you would like to use.