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What is a DEX?

A decentralized exchange, or DEX, is a cryptocurrency exchange that operates without a centralized authority. On a DEX, trading is executed via smart contracts on a blockchain. This means that there are no third parties involved in the transaction and that users have full control over their own cryptocurrencies.

Compared to centralized cryptocurrency exchanges, DEXs have no single point of failure — as users have full control over their own funds. There are two models of DEXs: order book and automated market makers.

An order book peer-to-peer exchange uses a bid–ask system to fulfill trades. The trade is only executed by the exchange’s matching engine when a trader’s buy/sell order is matched by the opposite order at a chosen price. Examples of order book-based DEXs include EtherDelta and IDEX.

On the contrary, automated market maker-based exchanges used a set of deterministic algorithms that outline the parameters to pool liquidity from traders and, thus, make markets. The funds for both buyers and sellers in AMM-based exchanges are stored in on-chain liquidity pools. Traders’ orders do not need to be matched with other traders’ in the liquidity pools. Instead, these pools ensure constant liquidity when traders deposit their assets into them.

Compared to order book exchanges, AMM-based exchanges work better with DeFi tokens. For project teams, liquidity pools removed the need to bootstrap a liquidity-providing network before the project delivers real utility. For investors, liquidity pools enable them to withdraw coins and tokens when they are not actively traded.

Decentralized exchanges have evolved to a billion-dollar market following the rapid DeFi ecosystem growth. As of June 2021, the monthly DEXs trading volume has surpassed $75 billion.