Decentralized exchanges (DEXs) are the opposite of centralized crypto trading platforms like Binance, Coinbase, Kraken, Upbit. DEXs provide users with a lot of freedom, allowing them to trade crypto without needing to register for an account. However, due to their decentralized nature and lack of support commonly seen with CEXs, it can be easy for users to make expensive mistakes when using DEXs. Therefore, in this article, we’ll highlight six helpful tips that will help traders safely and effectively trade on decentralized exchanges.
Overview of decentralized exchanges and how they work
A decentralized exchange (DEX) is a platform that operates on a distributed ledger such as a blockchain. It allows users to trade digital currencies in a trustless and secure environment without the need for intermediaries or third-party services. Unlike centralized exchanges, which rely on order books and KYC/AML measures, DEXs are powered by smart contracts, which are self-executing pieces of code on a blockchain.
In most cases, DEXs will swap tokens from liquidity pools, with liquidity provided by other users in exchange for a % of swap fees. DEXs typically don’t use order books to facilitate trading like Binance, Coinbase, Kraken, and other CEXs. Instead, they mainly use the automated market maker (AMM) model.
Due to its decentralized nature, crypto users only need a crypto wallet and some crypto (enough for any gas/transaction fees) to trade on a DEX. There’s no registration or account required of its users.
Benefits of using decentralized exchanges
1. Privacy: When using a DEX, users do not need to provide personal or identifying information for an account. All communication on the platform is done directly between users and smart contracts, meaning that no third-party service or intermediary can access the data.
2. Security: When using a DEX, users never lose custody of their funds until the trade or interaction is complete. This is possible due to the decentralized nature of DEXs, which rely on smart contracts and distributed ledgers rather than order books and trading systems used by centralized exchanges. As a result, users can securely store and trade their cryptocurrency from preferred cold wallets, which can help keep funds safe from bad actors.
3. Lower barriers to entry: Using a DEX requires only a wallet and some crypto to trade and pay gas fees. This makes DEXs highly accessible, as there is no need for registration or account creation. This also offers decentralization fans the opportunity to maintain control of their funds and data in a secure environment. However, users should still be aware of local regulations and laws when it comes to digital assets.
4. Accessibility: Since decentralized exchanges operate solely on a distributed ledger network, they are highly accessible and can be used by anyone, anywhere around the world.
5. Censorship resistance: With no central entity in control, users are able to access and trade cryptocurrencies without fear of censorship or limitations imposed by governments or other institutions.
6. Automated process: As DEXs use smart contracts and AMMs, it makes the trading process more reliable than normal order books used by CEXs.
Downsides of using a decentralized exchange
1. Liquidity: Since decentralized exchanges are not as heavily traded as centralized ones, users may find that liquidity is lower than what they would expect on a larger exchange. This can lead to higher spreads and greater slippage, especially during times of high volatility.
2. User interface complexity: Decentralized exchanges tend to have more complex user interfaces which can make it daunting for beginners and those who are not tech-savvy to navigate and understand how the platform works.
3. Lack of certain features: Because decentralized exchanges do not always have access to the same data as centralized ones, users may find that some features from more popular exchanges, such as margin trading or high leverage, are unavailable.
Helpful tips to trade on decentralized exchanges
1. Understand the AMM Model and how it works
The automated market maker (AMM) model is a protocol that helps facilitate trading on DEXs, without the need for order books or KYC/AML measures. AMM protocols match orders to liquidity pools that have been pre-funded by liquidity providers, allowing users to receive the best prices when making trades or purchases across multiple markets.
Understanding how this works is key to successfully trading with a DEX and can help traders maximize their returns in a decentralized exchange environment.
2. Research the DEX before trading on it
Researching a decentralized exchange (DEX) before trading on it is an important part of ensuring that users can safely and securely access the platform. Before diving into any DEX, users should research the platform’s features and functionality, fees, assets offered, order types, security measures, and more.
3. Use a secure wallet to store your crypto. Given DEXs interacts with users’ wallets directly, choosing a secure wallet can help ensure funds remain safe while trading on a decentralized exchange. There are many different types of wallets available. Some wallets offer more security than others, so it is important to find one that offers the optimum security features.
4. Familiarize yourself with market orders before trading
Market orders are the most common type of order used in a decentralized exchange, and it is important to understand how they work before placing them. A market order will execute at the best available price on the DEX, so it is important to understand the market and how it works if one wants to take advantage of this order type.
5. Monitor prices before trading
It is also important to monitor prices on decentralized exchanges, as there can be significant fluctuations between different DEXs due to their decentralized nature. This means that it is important to keep an eye on prices and try to trade on the DEX that offers the best prices.
6. Be aware of the risks involved in using decentralized exchanges
The risks of trading on a decentralized exchange should not be overlooked. While these exchanges offer users the chance to access global markets with greater privacy and censorship resistance, they also come with their own set of risks that must be understood before engaging in any trades.
Decentralized exchanges offer users the chance to access global markets with greater privacy and censorship resistance. However, it is important for traders to learn about how DEXs work and the risks associated with them before engaging in any trades. Understanding the AMM model, and using a secure wallet, among other things, can help users navigate the decentralized exchange settings, and also avoid some of the downsides.