Jigstack Academy — DEX
What Are Decentralized Exchanges and Why Are They So Important?
There have been few developments more impactful on the cryptocurrency market than decentralized exchanges (DEXs). They have been instrumental in opening up the market to more users, providing more utility to crypto assets, and have introduced other features that are broadly unavailable on centralized exchanges.
DEXs are still a nascent space, but they are so significant that any interested crypto user should know about them, understand how they operate, and recognize their value proposition. In this piece, we provide a brief overview on decentralized exchanges, how they differ from centralized exchanges, their inherent applications, and some of the most promising DEXs on the market.
What Are Decentralized Exchanges (DEXs)?
On a high level, DEXs are simply cryptocurrency exchanges that operate in a fully decentralized manner. They have no central authority overseeing the swap of tokens, and they are non-custodial, meaning you have custody over your assets at all times. You also do not have to register or create an account with a DEX, only using your cryptocurrency browser wallet to access its suite of services and features.
Some DEXs make use of Automated Market Makers (AMMs) to facilitate trades — we will explain this in more detail shortly — but there are others as well. The three major types are off-chain order books, on-chain order books, and the aforementioned AMMs.
The key takeaway here is that DEXs don’t have a central authority overseeing custody and swaps, which has many benefits to users, liquidity providers, and the market as a whole.
Why Are Decentralized Exchanges (DEXs) Better Than Centralized Exchanges (CEXs)?
There are a few critical ways in which DEXs differ significantly from centralized exchange (CEXs). Primarily, there is no central overseeing authority, meaning you are always in complete control of your assets. Anonymity is another huge plus, as there is no KYC process to undergo.
But perhaps the most essential advantage is the fact that DEXs can be extremely secure. You do not have to worry about your funds being affected if an attack takes place, as they have in the past on CEXs, resulting in hundreds of millions of dollars lost.
While DEXs have many distinct advantages, that doesn’t mean there aren’t some disadvantages as well.
One area where CEXs have an advantage is the ease of use. The interface of DEXs can be a little difficult to wrap your head around, even for a somewhat seasoned trader. That’s why DEXs offered by the likes of Jigstack are in such demand — they make the DEX experience much more intuitive.
CEXs also tend to have higher liquidity, though this is an issue that is being solved by innovative liquidity provision mechanics. This is not seen as a major obstacle — or at least one that is more easily surmountable.
Lastly, many CEXs offer fiat conversions, which again is a newbie-friendly feature. The support of fiat on and off-ramps is seen as a way to encourage adoption, so that’s one thing CEXs certainly have in their favor.
What Is an Automated Market Maker (AMM)?
In traditional markets, a broker or institution acts as the liquidity provider. They ensure that buyers and sellers can find enough of their counterparts to secure their trades. This is a centralized system, as it does not facilitate trades directly between individuals, known as peer-to-peer (p2p) trading.
However, an Automated Market Maker (AMM) is a system where users trade directly with each other through smart contracts. AMMs serve to maintain the price of an asset according to specific mathematical formulae based on supply, demand, and current trading pair liquidity.
Individuals can provide liquidity to a pool, becoming liquidity providers (LPs). These users are then rewarded for providing liquidity (taking the place of a traditional market maker), ensuring that there are enough counterparties to trade with. The LPs receive LP tokens that represent their share of liquidity provided to the pool, which often comes with high-return rewards.
Take Jigstack’s Stakbank, for example. Users can participate in a liquidity rewards program to earn a share of the STAK allocated towards the rewards pool. The STAK that they earn has multiple benefits within the Jigstack ecosystem, including within the token launchpad and the NFT marketplace.
The above benefits are some of the ways that LP tokens can be used to incentivize interaction in a DeFi ecosystem. So, the benefits are not limited to the immediate ones that result from using a DEX, but also from the extra rewards which can be utilized in a variety of ways. This has been one of the key drivers of the adoption of DeFi services — providing tangible value to end users without an intermediary.
How Liquidity Pools Determine a Token’s Price
Liquidity pools are at the heart of DEXs, as they are critical to the service of an AMM. Therefore, it’s worth knowing a little more about how they actually help determine the price of an asset.
Uniswap is a popular DEX that makes use of a relatively simple equation to determine price: x*y=k. K is a constant, and x and y are the prices of the two assets. The assets x and y fluctuate, but always remain a constant, which is one way of determining the token’s price.
Other DEXs use more complex models to determine the price, and occasionally they involve far more than two tokens.
These mechanisms are not perfect because they can result in something called impermanent loss. This topic is out of the scope of this article, but it is something that DEX traders should make a note of for further reading.
DEXs Are Here To Stay
The DEX market is certainly a new one, but by no means is it a passing fad. If anything, it will only increase in utility and quality as time goes by. So far, developers have been mostly working on the technical fundamentals, and only very recently have new and exciting use cases emerged.
While it is true that DEXs can be somewhat daunting to new users, efforts are being made to alleviate this bottleneck. DEXs will increasingly become a cornerstone of the overall market — and are already a significant cornerstone of the DeFi market.
With these developments, users will find novel and creative ways to utilize their assets, all while having full custody over them. Whether it’s a lending and borrowing service or just staking, the opportunities to make your capital work for you are about to increase tremendously.
Stay Tuned:
Jigstack is a platform that offers flagship DeFi products to interested users in the crypto and decentralized finance communities. At its core, it functions as a one-stop-shop providing users with a continuously increasing range of services useful to all participants, regardless of their experience levels.
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