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A decentralized exchange (DEX) is a platform that runs on a blockchain and enables peer-to-peer (P2P) transactions directly between cryptocurrency traders. DEXs operate in a non-custodial manner without the need for a custodian or centralized intermediary – such as brokers or banks – to facilitate the transfer and custody of funds1.
The main purpose of a DEX is to provide a more private, secure, and transparent way for users to trade their crypto assets. Users have full control over their funds and do not need to trust a third-party entity with their personal information or assets. DEXs also have lower fees and are more resistant to censorship and hacking.
The operation of a DEX involves the following steps:
First, users have to connect their wallets, such as MetaMask, to the DEX. This allows them to trade directly from their wallets without depositing their funds on the platform. Users can also choose from various blockchains and networks that the DEX supports.
Second, users can place orders on the DEX, either to swap or trade a certain amount of crypto at a certain price. The DEX will use an automated market maker (AMM) or an order book to match the orders with other users who want to trade the opposite direction. The AMM is a smart contract that uses a mathematical formula to determine the prices and liquidity of the assets. The order book is a list of buy and sell orders that are executed by the users themselves.
Third, users can execute the transactions on the DEX, which are verified and recorded by the blockchain. The DEX will also charge fees for the transactions, which are usually paid in the native token of the platform or the network. The fees are used to reward the liquidity providers, who supply their assets to the pools or the books, and the validators, who secure and maintain the network.
A DEX is a decentralized application (DApp) that runs on a blockchain network. It does not have a central authority or server that controls its operation. It is governed by software and users who can propose and vote on changes to the platform.
These are some of the main features and challenges of a DEX. I hope this helps you understand it better. If you have any more questions, feel free to ask me. 😊