Discover Decentralized Exchange: A Trustless and Permissionless Platform For Exchange of Cryptocurrencies
As the blockchain technology and cryptocurrencies are becoming more adopted, and more users are interacting with this technology, the issue of privacy and confidentiality breach set in.
Parts of the core values of cryptocurrency is to provide seamless and transparent transfer of value between parties, without revealing the identities of the parties, while also putting the users in total control of their assets.
Interacting with cryptocurrencies sometimes means exchanging a coin for another. This can be done from a peer to another, but this isn’t so reliable due to limitations in the amount that can be exchanged at a time. A marketplace where this can be done is necessary for effective and efficient exchange of assets.
This is where cryptocurrency exchanges come into play. These exchanges are platforms where buyers and sellers can meet through the order books, to exchange their assets.
How this basically works is that both parties send their coins to the exchange platform, and set their buying or selling orders to certain prices. When these preset conditions are met, the orders are triggered and the users receive their exchanged assets into their accounts on the exchange.
This kind of exchange is known as “Centralized Exchange”. Where the central exchanges keep the information of the users. Also, before a transaction can take place, users must transfer the control of their assets to the exchanges platforms. And with the “know your customer” policies, private information of the users are exposed to the central exchanges.
This somehow goes against what cryptocurrency basically stands for.
The solution to the shortcomings of centralized exchange is the inception of “Decentralized Exchanges”, commonly known as DEX.
Meaning of a Decentralized Exchange.
A decentralized exchange is basically an exchange platform that helps you exchange your assets directly from your wallet without giving away the control over your assets.
This simply means, the asset you want to exchange is taken from your wallet, and you receive the asset you exchanged for in your wallet in real time.
The transaction is done without revealing your identity to any platform, and you are in your total control.
Sounds like magic? Read to the end to understand how it works.
How DEX works
The early days of decentralized exchange was the introduction of DEXs like Etherdelta and ForkDelta. These early DEXs work almost like centralized exchange but don’t require your information, and you also control your assets. With these early DEXs, you create an order on the DEX’s smart contract, and when a counterpart order meets your preset conditions, your asset is exchanged, keeping it on the smart contract, where you can send it directly to your wallet with the click of some buttons.
The limitations to these early DEXs are low volume, and counterintuitive user interface, therefore they aren’t so efficient.
With continuous advancement in the cryptocurrency space, there are a lot of efforts to improve the decentralized exchanges. A successful approach is the innovation of Uniswap Protocol.
Uniswap is a decentralized exchange that enables you to exchange or as commonly called swap ethereum-based tokens for ETH or other ethereum-based tokens with no central parties. Uniswap greatly improved the counterintuitive user interface of early DEXs, and swapping tokens is as easy as punching the buttons on a remote control to change TV channels, like swapping TV channels.
As opposed to centralized exchanges, uniswap doesn’t use order books but instead liquidity pools are created for users to trade against. A liquidity pool contains an amount of a token and ETH in a proportion.
When these pools are established, the protocol tries to balance the amount of the assets in a pool, and this determines the price of the asset.
Warning: The explanation above could explode your brain if you try to read it again, but to help preserve that extraordinary brain of yours, further simpler explanation is stated below.
“Assuming you have a Token A, which you want to swap for Token B. You literally send the Token A into a liquidity pool containing Token A and Token B. And the protocol sends you the equivalent amount of Token B”.
This is quite easier to grasp, right? There you go.
This is how Uniswap exchanges your assets.
But how does liquidity pool work?
As stated earlier, liquidity pool is a pool containing assets that users can trade against. Under the hood, liquidity pool works in a completely different method compared to the “Order Book” system of centralized exchanges and older DEXs.
The pool works as explained below:
“Token A and Token B in the pool are maintained at a constant, such that;
A*B = K,
where K is constant.
Swapping A means you add more A to the pool and you take out equivalents amount of B.
To maintain this constant, it means that the next swapper of A would receive lower amount of B compared to the first swap, because there are more A and lesser B in the pool.
This system portrays the relationship between supply and price of an asset. That is, when there is larger amount of Token A in the pool compared to Token B, the price of A in B is reduced, and vice versa.”
The liquidity pool system gives little to no room for price manipulation as opposed to centralized exchanges.
Liquidity pools can be created or provided by anybody, called Liquidity Providers. Liquidity Providers earn the fees gotten from every transaction occurring in the pool they contributed to. This is how Uniswap generates income for the Liquidity Providers. Every swap attracts a fee of about 0.3%.
What Decentralized Exchange means for Traders.
Decentralized exchanges give users that are conscious of their privacy a platform to seamlessly perform their trading activities without the risk of exposing their identities to central parties.
Furthermore, trading on Decentralized Exchanges like Uniswap technically means that your asset never leave your custody, you just swap it for another asset that gets into your wallet in real time.
One limitation to most of the present DEXs is that the swap is between assets that are on the same blockchain, that is, ethereum-based tokens can only be exchanged for another ethereum-based tokens and ETH only, and not with, for instance other assets on Tron blockchain. But there are currently many approaches to get around this limitation, and efficient cross-chain swaps will be a thing in no time.
Also using DEXs attracts on-chain transaction fees for every transaction which might not be favorable to small scale traders, although these fees are insignificant on some blockchains.
The user interface of most DEXs are not easy to navigate compared to most centralized exchanges. Many projects aim to improve this aspect of DEX, so as to increase the traders’ interest in DEX.
How DEXs affect cryptocurrency projects.
Since anyone can create a liquidity pool, and anyone can contribute to the pool, and this is done without any fees, projects can easily list their assets on decentralized exchanges, without paying exorbitant fees as opposed to listing on centralized exchanges.
Also, assets listed on decentralized exchanges are free of price manipulation that could occur on centralized exchanges, at least to an extent.
Cryptocurrency aims to serve as a medium of permissionless, trustless and borderless transfer of value. These values most times are needed to be exchanged, and most of these exchange platforms defy what cryptocurrency stands for, in terms of privacy, trust and permission.
DEXs mitigate these limitations by providing a channel for exchange of assets in a permissionless and trustless manner.
The Delfy Advantage
Delfy, in its bid to develop a seamless platform for decentralized financing, aims to provide among others a decentralized exchange where you can carry out your trading activities easily with simple and intuitive user interface, and get the best user experience in the industry. More of what Delfy will offer you will come soon.
More of what Delfy will offer you will come soon. Learn more on the official website here.