Cryptocurrency Exchanges were the very first profitable business model for cryptocurrencies. They have always been an important piece in the crypto market and many have made millions trading on these exchanges. As the crypto space evolved, a new type of Decentralized Cryptocurrency Exchanges (DEXs) emerged. In this article, we will discuss what a DEX is? And what are the best DEXs out there?
History of cryptocurrency exchanges
Cryptocurrency exchanges began with the traditional or Centralized Exchange (CEX), where the platform acts as a middleman to buy and sell assets, and Market-Makers participate in both sides of a trade to add liquidity.
The Order Book is a crucial component that organizes buy and sell orders by price range, allowing traders to interact with the market.
Of course, this centralized design where people have to give custodial power over their crypto to the exchange had flaws. Exchanges with weak security, or outright scams, were the perfect vehicle for hackers to steal money from people. Several high profile hacks happened in these services such as Mt. Gox 460 million USD, Bitfinex 72 million, ZAIF 60 million, just to name a few.
These major hacks were the catalyst for developers to start designing a new type of exchange. One that would align itself with the core values of the Blockchain of decentralization and peer-to-peer transactions. The time had come for the Decentralized Exchange.
What is a Decentralized Exchange?
Source: HackerMoon
The Decentralized Exchange (DEX) is where people can trade without a central middle man. Now there are different types of Decentralized cryptocurrency exchanges (DEXs) out there.
In the early days of the concept, circa 2017, the first DEXs worked completely on-chain. This meant that transactions, the Order Book, and clearing were on the blockchain. This exchange was 100% decentralized but it also was very slow, and expensive since every action needed gas fee. Finally, these were difficult to use. Most exchanges of this type are no longer in operation.
The DEX is also part of the DeFi revolution a complete description of the trend can be found in DeFi Apps: What you Need to Know (2020).
Revolution of Decentralized Exchange
The second type of DEX is one where the Order Book is off-chain. The matching of buyers and sellers happens on a regular service that is being hosted on a server. People can quickly interact with the market. The clearing of assets is done by a smart contract running on a blockchain that gets called only after the order has been matched on the front end.
This is a popular system for peer-to-peer exchanges where buyers and sellers use the platform to find orders. Once an order is placed the parties deposit their assets in an escrow account that then releases the funds only after receiving confirmation from both sides.
Finally, some DEXs use smart contracts and liquidity pools to work. This type is protocol specific, meaning that it can only work with the assets of a particular blockchain. For example, Uniswap is only able to list assets of the Ethereum network.
The way they work is by using liquidity pools to create the market. In a liquidity pool, a user deposits an ERC-20 token and a matching value of Ether. For example, a DAI/ETH pool is one where a person locking 100 DAI has to also give an equal amount of ETH. If people are demanding more DAI than ETH, the pool will be drained of DAI which will be exchanged by ETH until it is completely depleted. If ETH is in more demand than DAI then the opposite happens. The liquidity provider gets fees by locking its assets to the pool.
Second, orders are matched using a smart contract that replaces the Order Book. These contracts interact with different liquidity pools and not other users. This way matching can be done entirely on-chain without the need of an intermediary.
What are the most popular DEXs out there?
As Ethereum is the current king of DeFi, it is no surprise that the most popular exchanges are on this network. These exchanges work using the liquidity pool and smart contract model and have become the most popular design. These are:
Uniswap
Source: Uniswap
The current champion of DEXs Uniswap is an exchange native to Ethereum. Additionally, it has a trading volume of 570 million dollars, which is more than double the daily average of CoinBase. Furthermore, it generates on average 1 million dollars in fees per day, making it one of the most profitable exchanges in the world of finance in general.
It has become the most visible face of the Decentralized Exchange. Many are trying to copy its business model not only on Ethereum but also in other blockchains. But for now, Uniswap is the king of the DEX.
Curve Finance
Source: curve.fi
Another DEX on Ethereum, Curve Finance has an average daily trading volume of 90 million dollars. It generates daily 60 thousand dollars in fees, making it the second most used DEX in the market.
1inch Exchange
Source: 1inch Exchange
This is a DEX aggregator that pulls prices from all the major Decentralized Exchanges of Ethereum in one platform. It averages 50 million dollars daily in volume. The exchange uses its token called Chi to lower gas costs, it reports 15 thousand dollars in fees, but this does not include the Chi token. So, the actual value is hard to determine.
The Exchange is alive and well in the world of cryptocurrencies. The DEX is taking the world of DeFi by storm, and it is expanding crypto adoption by the day. However, it is worth noting that this trend is currently mainly happening in Ethereum, given that it has the most assets. Although it is possible that another protocol may take the lead in the future, but regardless of the platform, the Decentralized Exchange is likely to remain a permanent fixture in the cryptocurrency landscape.
