• In most modern DEX, crypto-assets can only be exchanged within a single blockchain. Sometimes cryptoassets from different networks are added to DEX via crosschain bridges, but this complicates the trading process.
• Non-permanent losses are common on decentralized trading platforms.
• Decentralized exchanges have limited trading features, no familiar options such as different types of orders (e.g. Limit or Stop Loss) or leveraged trades. There are no additional tools, such as a ribbon or order book.
• Any trades, including those that are wrong or fraud-related, are executed automatically through the blockchain and cannot be reversed or challenged at the help desk. This is often used by cybercriminals to sell stolen cryptocurrency.
• The speed of exchange transactions in DEX depends on the speed of transaction confirmation in the blockchain and ranges from a few seconds to a few minutes. Therefore, high-frequency trading in decentralized exchanges is not possible.
• Decentralized exchanges typically have less liquidity than centralized venues. Therefore, when buying or selling large positions in low liquidity pairs, users may encounter so-called price slippage, which reduces the benefit to the user;
• Commissions for transactions in DEX are higher than in the centralized exchanges. In addition, users also have to pay network commissions.
• When exchanging assets and on large volumes, users can fall victim to price manipulation by MEV bots.
• Since most of today’s DEX does not have a centralized asset listing system, this is exploited by scammers issuing fake tokens to implement criminal schemes, including Pump & Dump and Rug Pull.
• Because of vulnerabilities in the smart contract code or web interface, DEX is susceptible to hacking and cracking. For example, on June 8, 2022, $5 million in assets were stolen from Osmosis DEX liquidity pools. Such incidents do not threaten exchange users’ funds, but can result in the loss of liquidity providers’ funds.

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Due to the ICO boom in 2017-2018, thousands of new crypto-assets appeared on the market. They were often traded on new DEXs such as EtherDelta, IDEX, DDex and others. Those ran mostly on the Ethereum blockchain and supported ERC-20 tokens. However, the standard problems of DEX at the time were low liquidity, large spreads, low speed, and too high transaction fees.

The real popularity of decentralized exchanges was brought by the technology of the Automated Market Maker (AMM). Instead of a traditional order book, it uses so-called pools of liquidity from asset pairs, and prices are calculated according to a mathematical formula based on their ratio in the pool. This makes it possible to create a decentralized architecture and guarantee onchain transactions via smart contracts, which are comparable to centralized venues in terms of execution speed.

AMM technology was first introduced by the Bancor project. However, the decentralized exchange Uniswap, launched in 2018 on the Ethereum blockchain, has become truly popular. Vitalik Buterin supported the project during its development.

Subsequently, the DEX-AMM model became the mainstream for decentralized exchanges and was copied for applications in other networks, including BNB Chain (PancakeSwap) and Fantom (SpookySwap). AMM-DEX also works in Solana, Cosmos, Terra and other ecosystems.

Liquidity providers to the pools receive commissions earned by the pool for exchanging assets of the respective pair. AMM-DEX has also gradually introduced other features, such as pharming, in which liquidity providers are automatically paid management tokens. These can then be sent to staking, used to participate in DAOs, or simply sold.

As of 2021, a new generation of DEXs is being developed. They, too, use AMM technology, but also allow the exchange of crypto-assets from different blockchains. For example, the Symbiosis Finance protocol implements this function using synthetic (“wrapped”) tokens. Another approach is offered by DEX from the THORChain project, which uses pools of native assets in different blockchains for exchange.

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Centralized exchanges are governed by specific legal entities that are responsible for the operation of the trading floor, preservation of users’ funds and compliance with laws.

This is why the management of centralized exchanges has access to customer funds, and why there was a capital outflow from CEX in 2022 amid the bankruptcy of FTX. The exchange administration was suspected of using customer assets, which led to fears of crypto asset loss among crypto activists and their withdrawal to cold and hot wallets.

If necessary, the management of a centralized exchange can block an individual user, a specific transaction, or an entire line of business – such as depositing or withdrawing funds. In addition, every new user who registers on CEX must undergo a verification of identity (KYC) procedure.

In turn, decentralized exchanges are not an intermediary in transactions, they do not store funds and personal data of their users. Customer identification is mostly done through blockchain addresses and non-custodial wallets, which are connected to the site via an app. Trades and other transactions on DEX are done via smart contracts.

Many decentralized exchanges have no governance. Key decisions are made by the community of management token holders by voting through the DAO. However, DEX often has a key developer who creates and develops the smart contracts or program protocol. The source code of the key components remains open.

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In essence, a decentralized exchange is a blockchain platform for peer-to-peer (p2p) transactions without intermediaries, which does not store user personal data and information about their funds on its servers. Users exchange assets using smart contracts and distributed registry-based algorithms.

So what do governments think of financial technology platforms that are essentially run only by the community of users themselves, with no central authority responsible for any transactions on such exchanges?

As with cryptocurrencies in general, the authorities of different countries do not come to an unambiguous position. For example, the Singapore regulator wants to create a new regulatory framework specifically for dexes, while the U.S. is trying to apply the existing one.

In most countries of the world, decentralized exchanges are not regulated because they are not tied to any individuals or legal entities. In the case of any violations, there is simply no one to bring charges or send formal inquiries.

Because the distinctive advantages of decentralized exchanges – anonymity and security – are in line with the core tenets of blockchain, they are notoriously popular among advanced crypto-traders. The industry can well expect even greater growth and mass user adoption, thanks to the desire of new projects to simplify the user interface and popularization among ordinary cryptocurrency users.

Decentralized exchanges answer the main demand of the cryptocurrency world: users do not want and should not trust their data and funds to third parties.

Thanks to the spread of decentralized finance, we can expect a significant technological development of projects and the introduction of a wide range of new features in dexes.

In addition, we can already see that centralized crypto exchanges are adding DEX functionality to their infrastructure because they see some demand. Among other things, this fact positively affects the growth of trading volumes of decentralized exchanges.

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