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What is Decentralized Exchange? Will it replace Centralized Exchanges?

21 Jul 2022 By : Sourabh Agrawal
Southeast Asia’s Lar

Decentralized exchanges (DEXs ) have grown significantly. However, their uptake has lagged behind that of centralized exchanges. 

Since the introduction of Bitcoin in 2008, experts have suggested that financial innovations like the tokenization of assets and decentralized ledgers, together with the blockchain technology at its core, will replace traditional financial services.

As a result, a new kind of blockchain application has emerged term decentralized Finance(Defi). DeFi offers financial services that generally rely on centralized financial intermediaries using open-source smart contracts on blockchains.

The Ethereum blockchain-based decentralized exchanges are one of the most well-known DeFi innovations. Instead of depending on central intermediaries, most of these exchanges use an Automated Market Maker (AMM) smart contract, which creates the market using a deterministic algorithm.

It is important to pay attention to emerging decentralized exchanges with a focus on fresh innovation. The new Integral DEX serves as a good illustration of how to construct DEXs by combining the AMM and order book concepts. The exchange would be able to mimic rival order books using its own, lower liquidity reserves due to this new hybrid DEXs' potential to release money from depth.

Decentralized Exchanges: An Innovation 

Dex is a peer-to-peer marketplace that manages the transfer and custody of assets in a decentralized form( removes the intermediary). In comparison to centralized exchanges, a DEX has no accounts, Know Your Customer checks or other specific limitations on who can use it. They are trustless and permissionless, enabling anybody with a cryptocurrency address and funds to utilize them.

As a result, users are unable to store any cryptocurrency on a decentralized exchange and must instead connect through other cold or hot wallets. Once a wallet is connected, the user may use the Decentralized Exchange as a DeFi (Decentralized Finance) gateway and trade any cryptocurrency stored therein anonymously. They can also access dApps and related protocols there.

DEXs is innovative in many ways:

  • Once a transaction has been validated and added to the blockchain, it is instantly settled. Until settlement, traders continue to have complete ownership over their tokens. For the users, this reduces counterparty risk.

  • Second, users can conduct transactions without being paired. Instead, by interacting with the smart contract, they are given immediate access to the available money. 

  • Unlike conventional centralized exchanges where most of the liquidity providers are experienced market makers, anybody who has a token can work as a liquidity provider by depositing their tokens and collecting commissions from trading activity.

Decentralized exchanges (DEXs) provide consumers more security since there is no single point of failure, in comparison to centralized exchanges (CEXs), which can be easier to hack.

Adoption of Decentralized Exchanges

Even though DEXs have had enormous development to date, engagement with them has not yet attained the levels of adoption as compared with their centralized equivalents as they are complex and not user-friendly.

DEXs frequently struggle with limited liquidity, which is significantly influenced by the number of users actively trading on the platform, which is not a problem in CEXs.That means DEX needs more cross-chain links and development to compete with CEXs and most of the platforms are also working on it. According to recent news reports from CoinGabbar, DEX platform Injective Protocol (INJ) propaganda more than 100x gains after launching cross-chain support for Cosmos.

Here is how to change it so that everyone can access what DEXs can offer.

DEX aggregators

These problems require a broad strategy to be solved.DEX aggregators can be a solution as they provide a practical solution by combining information from many exchanges to present users with the most competitive pricing. In addition, liquidity is being improved.

Due to traditional finance's inability to include people, many people, mainly in developing countries, remain unbanked and disenfranchised. A new financial avenue for tackling these problems is provided by DeFi and DEXs. While doing so, financial goods are made available to everybody utilizing decentralized infrastructure and it requires nothing more than a smartphone with an internet connection.

DEX aggregators, often referred to as liquidity aggregators, are particularly well-liked by active traders because of their many advantages. DEX aggregators have gained so much popularity due to these benefits-

Liquidity

For traders looking to trade huge volumes of digital tokens, DEX aggregators provide a larger pool of liquidity. For instance, it could be challenging to convert a sizable stake in a freshly released token into a stablecoin on a single decentralized exchange, due to the lack of liquidity.

But if you use a liquidity aggregator, you have a better chance of locating the liquidity you require to liquidate your token position without causing excessive slippage.

Privacy

A liquidity aggregator allows users to trade one digital asset for another online without requiring them to go through a KYC onboarding process, in contrast to CEXs which typically need users to have a crypto wallet and a working internet connection. There won't be any paperwork or ID verification required of you.

Better Execution Price

A DEX aggregator will often provide you with a better execution price than a single DEX. Aggregators are designed to help traders fill transactions as efficiently as possible across various liquidity pools. So it makes sense to employ a liquidity aggregator rather than just one decentralized trading platform for traders and investors who are price sensitive.

User-Friendly

Liquidity aggregators enhance the decentralized trading experience by offering simple dashboards that enable millions of digital tokens to be traded in a matter of seconds with just a few clicks.

Future

DEX aggregation is about to become widely used. Users have the interesting opportunity to link several DEXs from various blockchain ecosystems. These DEXs' integration is already in progress. Once finished, it will be a significant step in ensuring DeFi has a multichain future.

Future work should focus on defining time-driven financial instruments and applying decentralized exchange to other typical business tasks like online ticketing or commoditization of other daily items.

In order to increase the security, efficiency, and user-friendliness of the overall system, further, development is required in the interoperability, organizing data, and execution process.

Connectivity or Interoperability

DEX aggregation's growth depends on connectivity. A few suggested approaches to protocol communication, including atomic swaps or wrapped tokens, fall short of resolving the fundamental problem of interoperability. Both are ineffective on a large scale. Native cross-chain swaps are a significant technological advancement that has already proven their potential to enable interoperability at scale in real-world applications.

One of the core elements for aggregators like Spotify or Netflix is web interoperability. It is frequently ignored. These platforms have built their commercial success around the identification and commoditization of supply in a web of abundant data.

Aggregators can be used to provide Web3 developers with an open, permissionless API with further development and more liquidity sources. Users may make use of the integrated liquidity pools in several cutting-edge cross-chain use cases and applications.

Organizing data

Data aggregation adds an additional layer of value for the individual user on top of the non-custodial advantages of each unique DEX.DEX aggregators are giving current DEXs a new way to access the assets and liquidity of other DEXs in a different environment by building on the capabilities of the CEXs.

Tools are required to collect and organize the continually growing amount of data. In the same way, as Oyo doesn't own a single bed, neither do Flipkart or Zomato own any of the listed things. However, each platform is heavily used because of its capacity for aggregation.

The emergence of new marketplaces will be promoted by the removal of obstacles between older databases and the availability of open data. They can profit from the reduced cost of verification and trust.

Conclusion

Although the first decentralized exchanges originally appeared in 2014, these platforms didn't really take off until decentralized financial services based on blockchain gained popularity and AMM technology enabled DEXs to overcome their earlier liquidity issues.

DEX is a fantastic development in the DeFi arena brought about by censorship-resistant, privacy, and fully decentralized distributed ledger technology. DEXs have the potential to provide millions of people with a world of opportunity by pursuing the idea of democratizing finance. They can provide access to financial services including loans, payments, and borrowing.

The final hurdles to DEX adoption will disappear once these features are in place, and DEXs will start to take market share away from CEXs. The accessibility, simplicity, transparency, pace of innovation, and censorship resistance that DEXs can offer cannot be matched by CEXs.

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