What are DEXs and How do they Work
An Introduction to the landscape of Decentralized Exchanges
If you’re someone who is just entering the space of decentralized finance and is a bit overwhelmed with all the technical jargon, then this blog is just for you. In the next 4 minutes you’ll understand everything what is a DEX and how do they operate.
So let’s dive in.
Picture this: you’re at a bustling garage sale, surrounded by tables overflowing with knick-knacks, old toys, and clothes that no longer fit. You walk up to the vendors, inspect their offerings, and haggle for the best price. You exchange your money for the goods you want, and leave with your purchases in hand.
Now imagine a similar scenario, but instead of trading physical goods, you’re trading cryptocurrencies. That’s exactly how a decentralized exchange (DEX) works.
With a DEX, you get the capability to trade cryptocurrencies directly with other buyers and sellers, without the need for a central authority to hold onto your assets or execute trades. Instead of relying on intermediaries, the trades are managed through smart contracts on a blockchain.
You retain control over your assets and have the freedom to trade securely and privately, without having to trust a centralized organization with your investments. Think of a DEX as your very own garage sale, where you can trade cryptocurrencies directly with other buyers and sellers, without having to go through a middleman.
But how does it work on such a large scale?
At its core, a DEX is powered by smart contracts on a blockchain. These smart contracts act as the virtual agreement between buyers and sellers, automatically executing trades when the agreed-upon conditions are met.
When you want to make a trade on a DEX, you connect your cryptocurrency wallet to the DEX platform. This allows you to deposit your cryptocurrency and make it available for trade. Once you’ve deposited your cryptocurrency, you can browse the offerings of other buyers and sellers, looking for a trade that meets your needs.
When you find a trade that you’re interested in, you initiate the transaction through the DEX platform. The smart contract automatically executes the trade, transferring the cryptocurrency from your wallet to the wallet of the other party, and vice versa.
It’s important to note that, unlike a centralized exchange, a DEX does not hold onto your assets. Instead, you remain in control of your assets at all times, keeping them in your own personal wallet. This eliminates the risk of a centralized organization mismanaging your assets or becoming hacked, as all transactions are executed on the decentralized blockchain.
There are several different technical architectures that are being used to build these DEX’s
Order book-based DEXs: This is the most common type of DEX architecture and it functions similarly to centralized exchanges. Buyers and sellers post their orders on an order book, which is then used to match buyers and sellers. This type of DEX uses smart contracts to execute trades, but relies on a centralized order book to match buyers and sellers.
Automated Market Maker (AMM) DEXs: AMM DEXs use mathematical algorithms to determine the price of assets and execute trades, rather than relying on an order book. This type of DEX typically uses liquidity pools to hold assets, which are then used to calculate the price of assets.
Hybrid DEXs: As the name suggests, hybrid DEXs are a combination of order book-based and AMM DEXs. This type of DEX uses both an order book and algorithmic pricing to execute trades. The aim of a hybrid DEX is to combine the benefits of both types of DEXs, providing a more efficient and user-friendly trading experience.
Dfyn V 2.0 is an AMM DEX that uses concentrated liquidity pools and executes RFQ (Request for Quote) styled order. To know more about Dfyn V 2.0 architecture, check out this blog.
About Dfyn
Dfyn is the world’s first on-chain limit order DEX. It combines the power of an RFQ matching engine with a concentrated liquidity AMM.
