Exchanges are an integral part of human social life. In the beginning, there was only barter, where people switched one physical thing to another. Money's invention opened new ways of trading: people could sell their products and get money from them. However, different communities have different currencies, which led to the exchange's invention.
As technology evolved, we began to see many digital exchanges. They are great but they share the same flow: most are centralized. They have a single point of authority and are prone to censorship.
Crypto invention gave us a new way to exchange in a decentralized manner. In decentralized exchanges (DEXs) people are connected directly to each other, despite their location. They can exchange their tokens at a fair rate at any time of the day, wherever they currently live.
It’s a promising technology that has a bright future ahead. But how can it evolve? Will it replace traditional exchanges, or will it collapse in the next few years? Read this article to find out everything you want to know about decentralized exchanges.
What are Decentralized Exchanges (DEXs)?
So, what is DEX? A decentralized exchange (DEX) is a crypto exchange allowing direct token exchange without a third party. DEXs use self-executed smart contracts to automate and secure the trading process.
The first publicly available DEX was the EtherDelta project. Unfortunately, it didn’t last long. In 2017, hackers exploited a crucial vulnerability and stole $7.2 million worth of ERC-20 tokens. It was a blessing in disguise. This incident led to the development of new security protocols and advanced exchanges like PancakeSwap or Uniswap.
As of 2023, decentralized exchanges are popular spaces in crypto communities where users swap at a fair rate. DEXs do not require a third party to facilitate trades. It lowers fees and fastens execution times.
DEXs are not owned or operated by any single entity. In traditional finance institutions, there is always a middleman and a centralized authority. Crypto DEX exchanges don’t have a central point, so users become fully responsible for their funds. It can count as an advantage as well as a loss.
In centralized systems, a main server holds users' data. That middlemen are responsible for protecting funds and ensuring that they don’t get lost or stolen. If a hacker cracks that system and steals a user’s money, in most cases, those services are required to compensate you for lost funds.
In crypto, there are no main servers. If hackers exploit crucial vulnerabilities, there are 50/50 chances that services bring you back the money. It depends on the exchange and situation. If hackers crack your private key or phish you, there are even fewer chances to get your money back because it’s mostly the result of user carelessness.
All DEX deals are recorded on the blockchain. Anyone can see a history of transactions. It helps to track users who are doing suspicious transactions and sending dirty money to compromise people's wallets. On the other hand, this transparency gives opportunities to deanonymize the user if they act carelessly.
Benefits of DEXs: Why are they gaining traction?
The last years were the times of remote work and exploring online technologies worldwide. Crypto is one of the most disrupting online technologies right now. Once people earn money, they want to exchange a part for other tokens and try investing. Decentralized exchanges provide an easy and secure way to get almost any common token.
The most appealing thing about DEXs is that they are decentralized: they don’t have a central point of failure and have lower fees than traditional exchanges.
As I said before, if criminals hack a central server of a traditional exchange, they get access to the data on it. And it can include personal data such as full name, passport number, address, etc.
On the other hand, blockchain exchanges often store only your crypto wallet address. They don’t store private keys or potentially risky information. On the decentralized crypto exchange, you’ll get full control over your funds. You have a low chance of getting hacked if you behave carefully.
Most crypto exchanges adhere to the latest security measures like KYC and AML detection, which lowers your chances of getting hacked even more. Beware that DEXs are not completely anonymous. Your IP and wallet address can still be tracked.
All trades on DEX exchanges are recorded on the blockchain. You can verify the token authenticity with AML tools to ensure another person doesn’t provide you with illicit funds. With centralized exchanges, you can’t track the reputation of another user who sends you money, so your account may get blocked because you are receiving illicit money.
Decentralized exchanges are powered by self-executed smart contracts, triggered when both parties meet certain conditions. It’s vital to look for exchanges with secure smart contracts. You also should use tools with two-factor authentication and set a strong password on any crypto service that you are using.
Challenges and Criticisms of DEXs
Decentralized exchanges aren’t perfect. They have many advantages over centralized options, but at the same time, DEXs need to overcome many challenges, such as:
- security issues;
- scalability problems;
- limiting trading features compared to traditional options.
One of the main reasons why crypto is still not widely adopted is its complexity. It may take weeks or months to understand basic blockchain knowledge. And not as many people are ready to spend that much time studying a completely new industry for them.
Considering most DEXs have a complex interface, it becomes obvious why they still lack adoption. Centralized exchanges are more user-friendly. So, DEXs need to simplify the exchange process to attract more users.
This crypto complexity leads to security issues. Crypto exchanges are a new concept, and not so many people know how to correctly interact with them. It leads to phishing and scamming schemes where people voluntarily share private data with criminals.
Also, hackers can exploit critical vulnerabilities in DEX’s smart contracts, leading to mass token theft. Thus, users should pick the most secure options, which implement the latest security practices among the firsts.
Another crucial challenge for decentralized exchanges is scalability. Each network has its transactions per second (TPS) amount. Mastercard can handle up to 500 TPS, while Visa has 1700 TPS, and PayPal can verify nearly 190 transactions per second.
Crypto can’t brag about the same numbers. As of 2023, Ethereum can process nearly 30 transactions in seconds, while Bitcoin’s TPS is only 6. Decentralized crypto exchange scalability is dependent on the network’s rates. This slow speed lowers the possible adoption rate of crypto services, including exchanges.
Due to slow adoption, DEXs have lower liquidity than centralized options. So, there are fewer options to choose from when users decide to exchange their tokens.
Crypto exchanges also have fewer trading features. Blockchain is still a new technology, and people are still exploring its capabilities. Decentralized exchanges need more time and a clearer regulatory landscape to develop disruptive features.
DEXs vs. Centralized Exchanges: A Comparative Analysis
Despite decentralized and traditional exchanges providing the same service of exchanging one currency for another, they are different in many aspects. I’ve gathered all their differences in the big table to ease the comparison.
|Security||Potentially more secure, but still a developing technology||Potentially less secure, but currently is more established|
|Complexity||Complex||Typically easier to use|
|Regulation||Not regulated||Regulated in some jurisdictions|
DEXs are decentralized: they are not owned or operated by any single entity. They are more resistant to censorship and government control. On the other hand, they are far less regulated than centralized options. Centralized platforms often have legally established obligations, while in crypto, all operations are worked by trust and smart contract agreements.
Decentralized crypto exchanges are transparent, so all trades are recorded on the blockchain. You can verify the trade authenticity, the history of transactions, and their asset ownership. At the same time, all this info is anonymous: other people can only see your wallet’s address without any personal data. In centralized exchanges, users see your full name and card number, so they can identify you.
DEXs are potentially more secure than CEXs: they operate on a semi-automated blockchain base, reducing the chances of human error. It is nowhere to zero, but it’s noticeably lower than in traditional systems.
Smart contract implementation also lowers the chances of manipulation or fraud since they don’t allow the operation to run until both parties meet certain conditions. It is developing technology, and hackers can find critical vulnerabilities in some smart contracts.
As of today, CEXs have more resources to invest in security. So, in many aspects today they are more secure than the decentralized option.
DEXs are still new technologies with a far lower adoption than CEXs. That’s why many of them can have lower liquidity than centralized exchanges. There may be fewer buyers and sellers, which can make it difficult to find a great price for an asset.
On the other hand, DEXs have much lower fees than centralized exchanges. They do not need to charge fees to cover all the intermediaries.
The last comparison point is the complexity. Decentralized exchanges are more complex to use than CEXs. They require users to interact with smart contracts and understand the underlying blockchain technology. In centralized exchanges, users need to choose the service with the preferable rate and enter their card number.
Experts have different reactions to decentralized exchanges, but they all agree that those platforms are in their infancy stage, and can become the future of crypto trading. The scientists from the University of Sydney Business School say that DEXs are currently in their “wild west” stage where there are not so many rules, and participants still can influence platform development.
Journalists from CoinCentral agree with them, saying that DEX exchanges are only at the beginning of their journey. Even experts from more traditional banking industries see the DEX’s perspective. Technopedia experts tell us that there is a possibility that we will have centralized DEXs. Even though their name may sound bizarre, they can act as a middle ground, mixing best practices from both exchange types.
And I agree with all of them. Decentralized exchanges are in their infant stage, but they transform and disrupt the industry.
Future Projections: What’s Next for DEXs?
The future of decentralized exchanges looks promising. The more user adoption DEXs will get, the more liquidity they have. They can provide even more attractive exchange rates. And it will provide even more users to them, boosting the DEX's development. They will become more user-friendly and become an integral part of the crypto ecosystem.
DEX’s don’t have any central authority that can censor the service. They are transparent and mostly anonymous, and users have complete control over their funds. Smart contracts can automate the trading process, mitigating the human error factor.
But to get the desirable growth, we should overcome challenges such as poor scalability, low user adoption, and lack of regulations. I think that we will see slowly rising adoption until regulatory bodies adopt new laws aimed at DEXs.
After that, we will see a significant increase in DEX’s user base. It will lead to wider liquidity pools and interest among investors. We will see many layer-2 solutions that improve scalability and cross-chain solutions that allow users to trade currencies across different networks.
Those changes speed up adoption processes even more. We will see decentralized derivatives trading that allows users to trade derivatives on DEXs. It gives users more ways to manage their risk and hedge their positions.
Decentralized exchanges are forward-looking technologies that can change the crypto industry for the better. They are secure, and transparent, and don’t have a central authority and intermediaries between sender and receiver.
It makes them immune to censorship and less susceptible to human errors. But as for now, they have low user adoption, leading to a poor liquidity pool and limited trading features. Decentralized exchanges still lack proper regulation, lowering investor’s trust and slowing innovation processes.
During last year we got more regulations aimed at crypto, including laws directly affecting DEXs. So, I think that we will see a rising adoption of decentralized exchanges in 2024-2025. As they will get more users into their client base, investors may see them as a valuable asset.
Increased investments will lead to a development boom. DEXs will become more user-friendly, like centralized options. At the same time, they become an integral part of the crypto ecosystem, reshaping the crypto industry into a new, even more inclusive, and transparent path.