What is a Decentralized Exchange Platform?

What is a decentralized exchange platform, and why would anyone use one? If you’re new to the crypto space, you may have heard of something called a DEX; short for “decentralized exchange.” DEX platforms are growing in popularity among crypto traders because transactions are anonymous and you have more control over your digital assets. 

However, there are other important features that differentiate them from centralized exchange platforms, which are called CEX for short. While they do provide greater access to the digital asset market and the world of decentralized finance (DeFi), there are tradeoffs involved. Below is a crash course in decentralized exchange platforms for beginners, and the pros and cons to consider before using one. 

CEX vs DEX platforms: what’s the difference? 

The most important difference between a decentralized exchange (DEX) and a centralized exchange (CEX) is the presence of a middleman. Centralized exchange platforms use third-party intermediaries such as banks, brokers, payment processing companies, internal servers, etc. 

Decentralized exchange platforms, on the other, do not rely on these types of intermediaries to facilitate trading. Instead, DEX platforms provide automated peer-to-peer transactions, and the data is stored on a public ledger across thousands of computers, called a blockchain. 

Centralized exchange platform basics

Most centralized exchange platforms use their own internal order book. Each trade transaction is verified and the data is stored on the company’s internal server network. They are responsible for having the appropriate security protocols to protect assets held and traded on the exchange, as well as the data they collect and store. 

Before you can use a CEX platform, you need to fund your trade account with either traditional money, called fiat, or transfer in crypto from another digital wallet. CEX platforms usually have built-in digital wallets that automatically store your crypto for you. But since they hold the private keys to the built-in wallet, they control how your digital assets are stored and whether or not you can access them.  

Most centralized exchange platforms are regulated, which means they must comply with specific laws and regulations to prevent financial crimes like money laundering, terrorist financing, and fraud. Know Your Customer (KYC) recordkeeping regulations require centralized exchanges to collect a certain amount of personal information when you open an account. Typically, you need to provide your name, address, date of birth and sometimes photo I.D. Some exchanges may even ask questions about your employer, occupation, income, and how you plan to use your account. 

Decentralized exchange basics

DEX platforms do not use the same type of order books that CEX platforms use. Some use direct peer-to-peer trading, with a real person on the other side of the transaction. And others use math-based computer programs that trade automatically from liquidity pools, not directly with real people. I know, it’s all very Silicon Valley. But you don’t need to understand the tech to know that it gets the job done. 

Decentralized exchange platforms do not require you to create a user account, or provide any personal information whatsoever. There are no KYC reporting requirements, which means your DEX transactions are completely anonymous. The only information that can be seen are the public wallet addresses transacting on the blockchain.

You can trade instantly on almost any DEX platform directly from your private digital wallet. No need to transfer fiat or any of your digital assets onto the platform first. As long as your wallet is funded with the appropriate trading pair, you’re good to go. And DEX platforms don’t have built-in wallets that automatically store your assets either. You are responsible for storing them safely in your own private wallet that only you control. 

Things to consider before using a DEX

At Hardbacon, we want to help you make informed decisions about your digital assets because knowledge is power. Here are some pros and cons to consider before engaging with a DEX platform: 

The benefits of a decentralized exchange

DEX platforms give deeper access to the crypto market. And they provide other opportunities not typically available on centralized platforms, like the ability to buy a new coin before it goes parabolic; think Dogecoin and Shiba Inu. Below are some key advantages a DEX platform offers.

Non-custodial

DEX platforms are non-custodial which means they do not store your digital assets for you. You are responsible for storing and securing your crypto off the platform in a private wallet. You maintain full control over your crypto because literally no one can freeze your private wallet or deny access. Nor will you lose your assets if the exchange gets hacked, a server goes down, or it goes bankrupt. Remember Mt.Gox? Shudder. 

More privacy

DEX platforms are not regulated by a central authority, like a government or other official body. Therefore, they are not required to collect Know Your Customer (KYC) information like photo I.D. and other data. You can transact on a DEX platform without ever creating an account. Since no one is storing your info on an internal database, your personal information is safe from bad actors if the DEX were ever hacked. There is no banking or personal information that can be accessed and used for things like identity theft.      

Less expensive

DEX platforms cut out the middleman to allow crypto-enthusiasts to trade directly with each other or liquidity pools. Sometimes that can make DEX transactions faster and less expensive. Except for gas fees on the Ethereum network; again, I shudder.  Many major DEX platforms use something called Automated Market Makers (AMM); computer programs that use complicated math to ensure there is enough liquidity in the market to meet demand. That tends to drive down the cost of your trade. However, trading fees vary considerably among DEX platforms and can fluctuate further depending on network congestion. So DEX trades are not always cheaper depending on the network they use. 

Community funds

Having said that, every trade made on a DEX platform costs money too, but it works very differently. Centralized exchanges are private for-profit companies that make money every time you trade. However, decentralized exchanges are community-run, and members contribute to liquidity pools by staking their crypto. Every time a trade is made, a percentage of the trade value is distributed back to the liquidity providers. Whenever you use a DEX platform, your trade fee is going back to people like you who contribute to the network, instead of a corporation and its shareholders. 

Better coin selection 

DEX platforms offer a wider selection of digital assets including brand new, more obscure token projects that could be found on a crypto launchpad like PinkSale. By the time a coin hits a centralized exchange, it’s usually already in demand. Which raises the price significantly from its launch price. For example, those who purchased Dogecoin or Shiba Inu before they were listed on a CEX platform, enjoyed significantly better gains. 

Financial inclusion

Centralized exchanges are less likely to operate in every country, which can restrict access to the crypto market depending on where you live. Anyone, anywhere in the world can access a DEX platform. All they need is a smartphone. 

Drawbacks to consider

Of course, you should always do your due diligence before engaging in the crypto space. But that holds true in the legacy market as well. Below are some key drawbacks to consider before trading on a decentralized platform.

Safety and security

Since DEX platforms are non-custodial, you are solely responsible for your own security and the safe storage of your crypto. There is more room for human error on your part which could result in the permanent loss of your assets. If you lose or forget the private keys to your wallet, for example, you are straight out of luck. There is no IT department or customer support line that can reset your seed phrase or restore access. And because DEX platforms are not regulated, there is a higher degree of cryptocurrency scams like pump and dumps, rug pulls, honey pots, and fake tokens.  

Volatility and risk 

DEX platforms offer more obscure assets and trading pairs. That means there may not be enough liquidity in the market to complete your transaction, depending on the asset you’re trying to trade. New coin listings and tokens with small liquidity pools are much more volatile and risky. Relatively small shifts in trade volume can have a huge impact on price. While the project may be totally legitimate, a single trade could tank the price and leave you holding a bag of worthless crypto. 

Indirect access to the market 

You cannot purchase crypto on a DEX platform with fiat; traditional money like Canadian or US dollars. First, you need to purchase crypto with fiat on a different platform, most often a centralized exchange. Then swap it for crypto and transfer it to a private wallet. And you can only make transactions on a DEX with the proper trading pairs that are compatible with the platform’s blockchain network. 

Difficult for beginners

To use a DEX, you need to know how to use a private digital wallet, how to connect it safely to the platform and the proper blockchain network, how to send and receive crypto to the correct wallet addresses, and how to manage slippage or applicable gas fees to complete your transaction. It can be a complicated process for beginners, especially if they’re not particularly tech-savvy. There is more room for human error which could result in the permanent loss of your assets. Or at the very least, fumbling through a trading process you’re not used to that ends up costing you a lot more than it should have.