What Is a Centralized Exchange? What You Need to Know About DEX

Last year, the DeFi wave changed the way people trade cryptocurrencies. One of the key factors of this revolution is the emergence of decentralized exchanges (DEX) – a trading platform completely different from traditional exchanges. So exactly what is a decentralized exchange and why is it attracting so much attention?

Understanding DEX – What Is a Decentralized Exchange?

A DEX (Decentralized Exchange) – or decentralized trading platform – differs fundamentally from centralized CEX (Centralized Exchange) platforms in three main aspects:

On-Chain Transactions

Unlike centralized exchanges that store data on private servers, DEX executes all transactions through smart contracts on blockchain. Each transaction must be validated by the network, ensuring transparency and security, although this means you must pay certain gas fees.

No Identity Verification Required

Users can access any DEX with just a decentralized wallet without going through complex registration or KYC verification. This creates freedom and full control for users, though it also carries certain risks.

Direct Asset Control

On DEX, you hold tokens directly in your wallet instead of sending them to the exchange. This significantly reduces the risk of losing funds due to management errors or exchange attacks.

The Development Journey of Decentralized Exchanges

Early Stage: Copying Old Models

Initial DEX platforms like Bancor and Kyber tried to replicate the order book trading model (order book) from centralized exchanges onto blockchain. However, because each transaction required on-chain validation and high gas costs, the user interface became slow and unattractive. These platforms did not attract much market attention when launched.

Turning Point: AMM and Uniswap

Everything changed when Uniswap appeared with a completely new approach – Automated Market Maker (AMM). Instead of relying on order books, Uniswap allows users to swap tokens directly and quickly within their wallets.

How does the AMM mechanism work? Instead of dedicated market makers, liquidity pools are created by ordinary liquidity providers (LP). They deposit two types of tokens in certain ratios into the pool, and when users trade, prices fluctuate based on a constant mathematical formula.

Basic AMM Formula:

X × Y = K

Where X and Y are the quantities of two tokens in the pool, and K is a constant. No matter how many transactions occur, this product remains unchanged.

Real-World Example:

Suppose a liquidity pool has 10 ETH and 100 USDT. If you want to swap 1 ETH for USDT, the ETH in the pool will increase to 11. To keep K constant, the USDT amount must decrease, and the difference is the USDT you receive. Of course, in practice, transaction fees and slippage also need to be considered.

[ETH] Explosion: Uniswap and Successors

Uniswap not only succeeded but also created a domino effect. The platform offers 0.3% trading fees to liquidity providers, creating strong incentives. After Uniswap, many other DEXs like Sushiswap, Pancakeswap emerged, also introducing liquidity mining – a mechanism that rewards LPs with tokens, increasing the total value locked (TVL[USDT] of the entire DEX ecosystem.

Currently, Uniswap holds over $8 billion in total value locked with an average daily trading volume reaching hundreds of millions of dollars. In 2021, Uniswap even surpassed leading centralized exchanges like Coinbase in trading volume.

The Future: Can DEX Replace CEX?

( Advantages of Decentralized Exchanges

What is a decentralized exchange from a user perspective? It is a platform that offers:

• Simple and intuitive trading experience
• Low initial capital requirements to participate
• Incentive mechanisms to attract liquidity providers
• Freedom to trade without concerns about censorship

These advantages have helped DEX grow rapidly in user numbers and market share.

Current Limitations

However, AMM is not perfect. Challenges include:

• High costs: Gas fees on the chain are still higher than CEX
• Only supports instant transactions: Does not support complex order types
• Legal risks: The unregulated system may face future regulatory issues
• Liquidity: Some token pairs still lack sufficient liquidity

( Coexistence as the Expected Trend

Instead of one platform completely replacing another, what is a decentralized exchange in the future will be a complementary part of the ecosystem. DEX and CEX are likely to coexist, each serving different market needs.

Conclusion

The advent of AMM and Uniswap marked a milestone in the history of cryptocurrency. What is a decentralized exchange is not just a new technology but also a symbol of decentralization in finance. With clear advantages in control and accessibility, DEX has proven its value. However, current limitations also show that the road ahead still has many challenges to overcome.

Disclaimer: Cryptocurrency trading carries high risks and may lead to the loss of your entire investment. This content is for educational purposes only and does not constitute investment, financial, or legal advice. Please thoroughly understand the risks before participating in trading.