Decentralized exchanges are crypto exchanges without any central control. They are literally the opposite of centralized exchanges which have management teams in charge of running them.
As decentralized finance (DeFi) exploded in 2020, it became necessary to have platforms that match the name, so decentralized exchanges came about.
With a decentralized exchange, you can access DeFi tokens that you wouldn’t find on centralized exchanges. This offers investors more options to choose from so that they can easily invest in low-cap assets.
Decentralized exchanges also work differently from centralized ones. While centralized exchanges use order books to place and fill orders, decentralized exchanges use liquidity pools to allow users to swap tokens.
Liquidity pools are pools of assets that traders can use to trade their own assets with. Without liquidity pools, users will not be able to trade their assets and can get stranded on the exchange. Therefore it is an important component of the decentralized exchange set up.
When using a decentralized exchange, another advantage is that your funds never get to leave your wallet. Instead, you connect your wallet to the exchange and then trade directly from there.
If you’ll get involved with DeFi, you’ll likely need to use a decentralized exchange. They also have their shortcomings though.
It is only on decentralized exchanges that liquidity can be withdrawn, leaving users with tokens they can’t sell. It is therefore important to choose your decentralized exchange carefully, and here are some factors you should consider when choosing it.
High Liquidity
With all that has been said about liquidity, it should go without saying that a decentralized exchange without good liquidity is no place to be. Users won’t be able to swap tokens if there’s no liquidity, which makes the exchange entirely useless.
If you wish to use a decentralized exchange, check to see that it has deep liquidity so that you can easily swap tokens and take profits when you want to.
Use an AMM
Automated Market Makers (AMMs) are a group of decentralized exchanges that use algorithmic “money robots” to make it easy for individual traders to buy and sell crypto assets. By its nature, an AMM supports more digital assets, which gives you more options to deal with.
You’ll be able to access and trade many more assets than on a regular decentralized exchange. Therefore if it’s possible, you should always choose an AMM when you’re deciding on a decentralized exchange to use.
Security
The security of the platform you wish to use is very important, especially for a decentralized exchange. Unfortunately, they don’t have teams like centralized exchanges that you can evaluate. So how do you decide which is more secure? Reputation!
Although you can’t tell if a decentralized exchange is safe just by looking at it, you can tell how reliable one is by looking at its reputation. How long has it been around for? Has it been breached before?
Exchanges like Uniswap and Pancakeswap which have been running for years without issues come to mind.
If you use them, you can be fairly sure that liquidity on the platform will not be withdrawn, and that you’re not likely to be left stranded with a useless token because of low liquidity.
Unlike centralized exchanges, decentralized exchanges are built on blockchains. Uniswap for example was built on Ethereum, while Pancakeswap was built on BNB Smart Chain. There are also multi-chain exchanges which work on multiple exchanges.
The blockchain a decentralized exchange is built on can determine your experience of using the exchange. For example, the blockchain can significantly affect the speed and cost of transactions on an exchange.
Ethereum for example costs a lot more to carry out transactions than BNB Smart Chain. This translates into the exchanges as well.
Therefore in choosing a decentralized exchange, you should consider the blockchain it was built on because it can make or mar your trading experience.
