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A DEX (decentralized exchange) is a type of cryptocurrency exchange that operates without a central authority, using blockchain technology. As a key part of DeFi (decentralized finance), DEXs use smart contracts to enable direct, peer-to-peer trading of digital assets.
Because DEXs are built on decentralized blockchain infrastructure, they usually offer higher security through open-source code. They also give users more control over their funds, as users retain ownership throughout the transaction. This is different from centralized exchanges (CEXs), where the exchange temporarily holds users’ funds to complete trades. DEXs are not subject to KYC/AML procedures, making them more accessible and resistant to censorship.
However, DEXs can be more complex and harder to use. They often have lower liquidity due to asset fragmentation across networks, higher slippage from fewer users, and potentially slower and more expensive transactions, especially during network congestion.
DEXs can be categorized into two types based on the trading mechanisms: automated market makers (AMMs) and order books.
Most DEXs use the automated market maker (AMM) model, which relies on liquidity pools—collections of tokens held in smart contracts. Trades are made against these pools, with algorithms determining prices based on the token ratios within the pool. This mechanism ensures that trades can occur at any time, reducing the dependency on market participants being available simultaneously. This results in smoother and simpler trades, especially for niche tokens.
On the other hand, order books, more common in CEXs, list all buy and sell orders for an asset, matching buyers and sellers at specified prices. This method acts like a matchmaker and relies on various price levels to provide liquidity.