Decentralized exchanges are peer-to-peer marketplaces where users can buy and sell cryptocurrencies without the interference of third parties such as banks and regulatory agencies. While this is good to helps maintain anonymity and privacy, it also has it’s own disadvantages. Transactions are automatically carried out when certain conditions written in a smart contract are met. Let’s take a brief look at what Decentralized exchanges (DEXs) and the possible advantages and disadvantages associated with it.
WHAT ARE DECENTRALIZED EXCHANGES (DEXs)?
Decentralized exchanges are marketplaces that allow traders to complete transactions without third party interference by help of written codes known as smart contracts. Unlike centralized exchanges, decentralized exchanges do not require a sign up or KYC process. Decentralized exchanges are popular for providing a platform where smaller projects make their tokens available for trading. This is so because it is open to all and allows liquidity to be added without any due diligence. This in fact has posed a problem as scammers use this opportunity to dupe investors.
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Contrary to the rigorous sign up and KYC processes required on centralized exchanges, on decentralized exchanges, users need to only connect their wallets on a particular network to the DEX they want to make use of to perform transactions. This simply means that first time users can complete their first transaction in a matter of minutes since they require no initial sign up and KYC process.
Although DEXs have helped to hasten transactions and maintain privacy of users, it has also posed some threats which will be highlighted in this article. Some examples of decentralized exchanges (DEXs) are Uniswap on ethereum network, Pancakeswap on binance smart chain network, Babyswap on binance smart chain, spookyswap on the fantom network, solarbeam on the moonriver network and so many others.
ADVANTAGES OF DECENTRALIZED EXCHANGES
The major advantage of trading on a dex is the privacy and anonymity associated with it. Most users make use of DEXs because they prefer to remain anonymous especially in countries where crypto regulations do not really favor investors. Some of the advantages associated with trading on a dex are;
Making use of decentralized (DEXs) exchanges helps protect users identity. This is so because it does not involve a sign up and KYC process as associated with centralized exchanges. KYC involves a process of collecting users personal information together with a legally accepted government issued identification document. This is a major advantage of DEXs because some users do not like their identity to be made public.
Security of assets
When making use of DEXs, users have full control of their crypto assets because the assets are not stored in the DEX in question. Unlike in centralized exchanges where users have to store their crypto assets in the exchanges wallet, in decentralized exchanges, the assets are stored in the users wallet and can only be assessed by the user or anybody with the wallet’s private keys. Users are advised never to reveal their wallet private keys to anybody.
No third party interference
One of the advantages of using a DEX is the ease of completing transactions without the interference of a third party. Transactions are completed in decentralized exchanges when they satisfy certain conditions written in codes known as smart contracts. This reduces the delay associated with peer to peer trading in centralized exchanges which may arise from bank network issues and the likes of it. In the case of decentralized exchanges (DEXs), transactions are completed automatically without any possibility of loss or delay.
DISADVANTAGES OF DECENTRALIZED EXCHANGES
In as much as using DEXs have become very popular due to the privacy and anonymity it provides, it also has some downsides and has in a way also increased the possibility of crypto related fraud cases. Some of the disadvantages of decentralized exchanges (DEXs) are;
Requires proper knowledge
Making use of decentralized exchanges requires a certain level of knowledge since it isn’t as straight forward as using centralized exchanges. First, it requires configuring a smart contract interactive wallet with the correct blockchain network of the DEX. Transactions will typically not work if the networks conflict.
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Then these wallets need to be funded with the native token of the network in question. This is necessary because the native token of the network is typically used as gas fee for transactions. Assets may get stuck in the wallet if gas fee is not available to move assets.
Sometimes transactions do not go through and the user has to adjust slippage manually to enable transactions go through. In some cases, slippage tolerance may be adjusted a couple of time. This not only causes delay, it also posses a difficulty for newbies who do not know how to use DEXs properly.
Smart contract security risk
Sometimes, smart contracts encounter bugs or security risks that lead to lose of funds of investors. While this may not be intentional with big DEXs, smaller DEXs with dubious developers may purposely write vulnerable smart contract so as to do away with investors funds.
Traders are advised to trade their assets with only well audited decentralized exchanges (DEXs) so as to reduce the risk of encountering smart contract vulnerabilities.
Increase in crypto related scams
Since projects listing on decentralized exchanges (DEXs) are not vetted, dubious developers tend to launch fake projects in order to scam investors. This is typically called rug pull where project developers pull out liquidity and do away with investors funds. This has been a major issue associated with DEXs and users are advised to research properly about projects before buying their token.
Also, legitimate projects most times tend to lock their liquidity in a smart contract locker so as to gain community trust. If a project doesn’t lock its liquidity, it is most likely gearing up to do away with investors funds.
Decentralized exchanges have really made things easy for traders and projects but has also in its own way increased the level of crime rate in the crypto space. In as much as it helps protect the identity of traders, it also helps protect the identity of dubious developers who tend to scam investors. Proper research should be done before making use of decentralized exchanges.