DEX is short for "Decentralized Exchange" - or a decentralized exchange. A decentralized exchange is an online marketplace where two parties can trade cryptocurrencies among themselves. This does not require the intervention of a third party. A DEX replaces the middleman in a transaction by using smart contracts on the blockchain.
Centralized exchanges (CEX), are online trading platforms that match buyers and sellers through an order book. Parties such as Kraken or Binance, for example, are a CEX. Typically, a CEX is easier to use, and therefore more popular.
A decentralized exchange (DEX), such as PancakeSwap or Uniswap, is powered by smart contracts that allow traders to exchange one token for another, with all transactions visible on the blockchain. A DEX requires more technical knowledge and is therefore less suitable for the novice trader.
Traditional financial transactions are inherently opaque. When you transfer money from one bank to another, you have to trust that the bank is doing the right thing. In most cases this goes well, but when a transaction is declined and reversed, it can take several days before the amount is returned to your account. In the meantime, you have no insight into where the money is and you can't track the transaction any further.
A DEX offers complete transparency in the movement of money. When a transaction is made, it is forever reflected on the blockchain, which is considered the ultimate piece of evidence. Another advantage of a DEX is that transactions are mutual and do not pass through a third party.
Although there is no use of a third party with a DEX, there are costs involved. DEX users typically have to pay two types of fees: network fees and trading fees. The network fee is not for the DEX but to send the transaction across the network - also called the gas fee.
Trading fees are for the underlying protocol, liquidity providers or token holders. These fees vary by protocol.
For example, Uniswap charges a liquidity fee for each transaction. This fee is shared among the pool's liquidity providers. Previously this was a fixed fee of 0.3%, but since the release of Uniswap V3, the fee is determined based on the volatility of the liquidity pool.
Trading cryptocurrencies is never without risk, so is using a DEX. Besides the standard volatility risks where your deposit can decrease in value, a DEX also has some DEX-specific risks. A DEX is decentralized; there is no one who can be held liable if something goes wrong. When processing a transaction, the smart contract must be relied upon. Although blockchains are considered very secure for conducting transactions, it offers no guarantees. The code quality of a smart-contract depends on the team that developed it.
Bugs, hacks and other vulnerabilities can occur in a smart contract, which usually puts you at greater risk of losing your money as a DEX user.
Another major risk of a decentralized exchange is supply. On many DEXs, anyone can create a token and market without permission. At a centralized exchange, every token or coin that is added is screened. All factors are considered before a coin is added to the supply. So with a DEX, you run a greater risk of buying a worthless token. Therefore, it is important to do good research on a token before buying it - paying extra attention to new tokens.
