Crypto brings with it a host of possibilities and technological solutions that would be completely unimaginable in any other sphere, and the first one that most users encounter is trading on DEXes (decentralized exchanges). While these new possibilities can be confusing for newcomers, they’re the building blocks of the rapidly growing DeFi (decentralized finance) space, and as such it’s never too soon to learn about them and start using them in practice. That’s precisely what we’ll cover in this post: we’ll start off with an outline of how DEXes work, which main types exist and, crucially, what you need to do to start using them yourself.
As the name implies, DEXes are decentralized, meaning that they aren’t controlled by any single entity, and there is also no need to deposit your funds to them in order to trade. Unlike centralized exchanges, you can trade on DEXes directly from your own blockchain wallet, whether it’s software or hardware-based, bringing an important improvement in terms of security (as you don’t need to hand over custody of your funds to anyone). In fact, a DEX isn’t any sort of an institution or entity in the traditional sense - it’s just some code on a blockchain that enables users to trade between different assets on that chain. DEXes work on any chain that supports smart contracts: Ethereum, Solana, Avalanche and many others.
There are two main types of DEXes based on the way that trading takes place, namely the orderbook and AMM (automated market maker) model. Orderbook DEXes feel much like centralized exchanges (or stock exchanges, for that matter): you post buy or sell orders, and these orders are filled when they’re paired with an order on the opposite side of the market. This tends to be computationally expensive, however, as each individual action - creating, modifying or canceling an order - needs to be recorded on the blockchain, and carries a transaction fee. Because of this, orderbook DEXes are mostly present on higher-throughput chains (such as Solana) or Ethereum Layer 2 rollups, rather than on Ethereum itself.
Due to the complexities of having an orderbook on-chain, the most popular DEXes use the AMM model, which relies on a liquidity pool and a mathematical formula to determine the price of assets, rather than having an orderbook with all the data that it takes up. In the AMM model, a trading pair (such as ETH/USDT) can be created by anyone, simply by depositing an equal value of ETH and USDT into a liquidity pool. Other users can then provide liquidity as well, and the more liquidity that is present in a pool, the easier it is for traders to make larger swaps between the assets without moving the price too much and incurring slippage.
This concept of a swap is where AMMs differ from orderbooks most noticeably: instead of a trade taking place when two opposite orders are matched, a trader can simply exchange the desired amount of ETH for USDT by depositing one asset in the pool and getting the equivalent value in the other asset into their wallet. The trader pays a trading fee on the swap (typically around 0.3%), which is mostly distributed to the liquidity providers, thus incentivizing users to deposit assets to enable others to trade. As trades take place, the price of the assets is automatically adjusted to maintain an equal value of both in the pool. some protocols, such as Balancer, offer different AMM models where the relationship between the assets’ value can be different, but the process of trading on them is mostly identical.
Now that you understand the theory behind them, how do you go about trading on a DEX yourself (and, since the process with orderbook DEXes is virtually the same as with centralized exchanges - minus the deposit part - we’ll talk about AMMs here)? Luckily, the process is just as brilliantly simple as the AMM model: once you’ve got the asset you’d like to sell in your wallet, simply go to the website of the DEX you’d like to use (with some examples being Uniswap, Sushiswap, Curve and Balancer) and connect your wallet. You’ll notice the interface is much less complicated than that of exchanges that use the orderbook model: all you need is to select which token you want to sell, which one you want to buy and enter the desired quantity, while the price at which the swap will take place will be automatically displayed.
If it’s your first time selling a particular token, the only additional step is that you have to send a transaction to approve the protocol to spend your tokens - after that, just click Swap and confirm the swap transaction in your wallet. Simple as that! The main precaution that you need to keep in mind, however, is that anyone can create a token and open a trading pair for it on an AMM DEX: this is why it’s critical to check the contract address for whatever you’re buying. The easiest way to do this is to find the token on a website like CoinGecko or CoinMarketCap, copy its contract address for the chain you’re using, and paste that on the DEX website to select the token.
While the DeFi space can seem scary to beginners, in reality it’s incredibly easy to start trading in the most decentralized, permissionless and secure way possible. As long as you’re careful with token addresses and avoiding phishing websites (which you can learn more about here), you’ll be good to go.
