Decentralized exchanges are digital marketplaces which allow traders to buy and sell cryptocurrencies directly on a blockchain - offering self-custody, transparency, and access to a greater variety of crypto assets than would be available on a CEX alone. Some traders prefer to use them because they reduce exposure to risks like custody of user deposits and a lack of transparency associated with centralized exchanges. Probably the more common reasons are to gain access to tokens not available on centralized exchanges, and to avoid having to go through often-cumbersome centralized onboarding processes. That said, using decentralized exchanges requires a higher degree of crypto-familiarity and certain onboarding hurdles which must be overcome.
There are more than 1000 decentralized exchanges today, across many different blockchains. This might make choosing a DEX to use challenging for the beginner trader. In this article, we will look at the fundamental concepts around decentralized exchanges, as well as the criteria to consider when making an informed decision about where to trade crypto.
A decentralized exchange (better known as a DEX) is a peer-to-peer digital marketplace that enables traders to buy and sell various cryptocurrencies without relinquishing custody of their funds to an external intermediary.
The key difference between a DEX versus a centralized exchange (CEX) like Coinbase is that DEXs operate natively on a blockchain, which introduces a new set of benefits and drawbacks which traders must take into consideration.
Transaction Fees - Unlike using a financial intermediary like a bank or brokerage firm, transactions on a blockchain are processed by a network of nodes known as validators, who must be in majority-agreement or consensus about the validity of a transaction. Distributing this responsibility of processing transactions across multiple entities as opposed to a single one is key to the decentralization of blockchains, though it also means that given that validators are responsible for verifying, ordering, and executing transactions, users must pay an additional transaction cost known as a gas fee for this computational effort.
Self-Custody - Users trade assets directly from a self-custodial wallet, which means they do not need to deposit any funds to the DEX itself. On one hand, this means traders do not have to trust that the exchange will not allocate their deposits elsewhere; on the other hand, it means traders must create a self-custodial wallet and transfer funds over to it before they can trade on a DEX, meaning they cannot enjoy the convenience of buying crypto with their credit or debit card as they can on Coinbase or Binance.
Code - Trading functions on a DEX are enforced by lines of code known as smart contracts, which are constructed on the premise that “Action X will execute if Condition Y is met”. This removes the need for intermediaries and ensures that no additional actions outside user-specified instructions will be executed.
Visibility - Every action recorded on the blockchain is publicly observable, enabling users to observe the full contents of their transactions after execution.
Anonymity - Blockchains preserve anonymity for users as they do not require any personal information or approval process to sign up. Instead, users set up a self-custodial wallet from which they trade crypto assets from
At their very core, all DEXs are simply sets of smart contracts programmed to interact with one another and emit specific outputs based on specific inputs, settling all transactions on one or more blockchains. Yet their implications are far more complex, as they represent a shift in the function of trading as they enable anyone to become a part of the trading protocol and be a beneficiary of trading activity and growth. Users can lend out their funds to be traded in exchange for earning fees resembling interest payments, or if a DEX has launched its own token, holders can receive a portion of the earned fees as part of a revenue share system.
Traders may wish to consider using a DEX to trade crypto assets if they are looking to avoid trusting a centralized intermediary with funds, want to access a greater variety of tokens to trade, wish to preserve their anonymity when trading, and value the ability to observe the contents of their transactions on-chain.
It should be noted that a fair degree of facility with crypto is required to effectively trade on a DEX as there are multiple prerequisites involved, including acquiring crypto with fiat, setting up a self-custody wallet, and successfully transferring enough funds to the wallet to be able to trade and pay for gas fees.
There are a multitude of factors to consider when analyzing these blockchain-native digital marketplaces. Some criteria for selecting the best decentralized crypto exchange are:
Launched in 2018, Uniswap was the first DEX to gain major adoption and is the model that most major DEXes are based on. Uniswap pioneered the Automated Market Maker (AMM) model, which facilitated price discovery based on market demand and available liquidity to trade. Uniswap was the first DEX to enable permissionless participation on both sides of the trade, meaning traders could swap supported assets with a simple and intuitive front-end, and anyone could provide liquidity to liquidity pools used for facilitating trade to earn trading fees. Uniswap has long been the number one decentralized exchange across a number of different metrics, including trading volume, liquidity, and active users.
PancakeSwap launched in 2020 as a clone of Uniswap on BNB Chain. It is the top DEX on BNB Chain. Users can swap assets with low fees and provide liquidity on a user interface almost identical to Uniswap’s. Additionally, users can stake assets across various pools to earn yield. Many users choose PancakeSwap because of the relatively low transaction fees on BNB chain and the DEX’s high volume and liquidity.
Curve Finance is the second-largest DEX on Ethereum by TVL, launching 2 years after Uniswap in 2020. On Curve, users can swap assets and/or provide liquidity to earn fees, stake assets across various pools to earn additional yield, and participate in protocol governance by staking the native $CRV token. Originally, in V1, Curve only offered Stablecoin <> Stablecoin swaps, but has since integrated many other trading pairs in V2, otherwise known as CryptoSwap. One key distinction of Curve is that liquidity pools are structured to accommodate similar asset classes (like USDC/USDT or ETH/WETH) to provide users with a better trading experience through lower fees and slippage.
Orca launched in 2021, and has emerged as the top DEX on the Solana network. On Orca, users can swap assets, and provide liquidity on a user-friendly interface, with low fees and fast transaction execution due to Solana’s performance. Similar to Uniswap, Orca utilizes an AMM model to facilitate price discovery based on available liquidity at a given time.
Sun launched in 2020, and is the largest and most popular DEX on the Tron network. Sun offers many of the features native to other DEXs, such as SunCurve for stablecoin liquidity pools, or directly on the Tron network. Users can swap assets, provide liquidity, earn yield by staking assets, and participate in governance with their token holdings directly from the Sun front-end.
THORChain launched in 2021, as a decentralized cross-chain exchange which also serves as its own blockchain network. Users can swap assets across different blockchains, provide liquidity to earn trading fees, and borrow and lend funds as well. THORChain enables transfers across Bitcoin, Ethereum, BSC, Avalanche, Cosmos Hub, Dogecoin, Bitcoin Cash, and Litecoin. Given the additional computational effort involved in swapping across different networks, THORChain charges an inbound, affiliate, swap and outbound fee.
SushiSwap originated as a Uniswap fork (a nearly identical codebase) intended to draw users away from Uniswap by providing nearly identical features but with higher rewards, otherwise known as a vampire attack. The protocol has since grown into its own niche, offering numerous functions for users paired with its distinct Japanese restaurant-themed branding to offer a unique user experience. Users can swap assets, provide liquidity, borrow and lend assets, as well as stake the native $SUSHI token to participate in governance.
Synthetix, launched in 2017, is one of the oldest DEXes. It was the first decentralized exchange to allow traders to access synthetic assets - tokens pegged to the price of not only cryptocurrencies, but also real-world assets like commodities and fiat currencies. Since then, the protocol has evolved to offer perpetuals trading and a handful of other on-chain financial instruments such as the sUSD stablecoin. It should be noted that there is no front-end for Synthetix itself - only supporting applications built on top of the protocol’s infrastructure, such as Kwenta and Lyra Finance.
Similar to THORChain, Osmosis is a DEX which exists as its own blockchain network, or app-chain. This means users who wish to trade on Osmosis will need to purchase the native $OSMO token to pay for transaction fees. Users can swap assets, provide liquidity across various pools, stake assets to earn yield and participate in on-chain governance directly from the Osmosis front-end. Furthermore, Osmosis offers many customizable tools and features for creating various liquidity pools. One advantage of being structured as its own blockchain network is that transaction fees on Osmosis are notably lower than on other DEXs which live on major networks like Ethereum. Traders often come to Osmosis as there are many tokens listed that are not easily available elsewhere, like Celestia’s $TIA token.
Balancer launched in 2020 and is modelled after Curve Finance. Users can swap assets, provide liquidity, and stake the native token to participate in governance. Unlike the original Uniswap model which utilized a 50-50 asset ratio for liquidity pools, Balancer is known for its unique 80-20 liquidity pool model, built to provide deeper liquidity for traders, and to help liquidity providers mitigate impermanent loss and earn higher fees.
DEX traders should be aware that there is no way in DeFi to revert transactions on a users’ behalf. Hence traders who use DEXes are typically familiar with on-chain trading fundamentals, as well as the common risks associated with crypto trading.
Let’s take a look at some of the DEX-specific risks that exist:
Onboarding and Navigation Difficulty
Smart Contract Risk
Decentralized exchanges are a pillar of blockchain ecosystems today. Operating natively on a blockchain enables greater transparency, and privacy, but it also entails important risks and other issues. Trading on a decentralized exchange is the first step towards being onboarded to the on-chain DeFi economy. Understanding how these digital marketplaces function and their respective pros and cons helps a user perform due diligence and select the best decentralized exchange for them.