Why should you trade on decentralized exchanges?

Benjamin D. - Founder

Decentralized exchanges extend the ability to place a buy or sell order on your desired asset, at any time and any place. You benefit from your choice of trading platforms, without having to register for countless others.

Which fees you want to pay are up to you. The distributed ledger, or blockchain, works to ensure that lesser fees are charged, regardless of your invested capital.

Another advantage of decentralized exchanging is the DLT’s magnified transparency. You continually gain insight into what is taking place behind the curtains, as well as when your order is prompted. If you trade on a traditional trading platform, you cannot instantly determine who initiates your purchase and when, nor at what time the investment ultimately ends up with you. The fee makers’ cost frameworks also remain hidden.

At the same time, you relish the advantage that the data is not anonymous, but pseudonymous. In short, your transactions are visible to you through identification numbers. This allows the user, you, to determine how to properly use the data. For example, you can transcribe the statistics to an application that automatically generates a tax report for your transactions. You determine the manner in which you trade, as well as the platform provider.

What assets can be traded on a decentralized exchange?

Any asset in digital form can be traded. These can consist of classic cryptocurrency assets like Bitcoin, synthetic assets, or derivatives like futures and options. Investing in ETFs and index funds is also feasible. Check out this article about Synthetic Assets for additional details.

Who operates a decentralized exchange?

In comparison to traditional brokers, the decentralized exchange is driven by the users themselves. A free market is established via the correlation of supply and demand. Supply and demand are regulated by a smart contract that sets the rules for all participants. The smart contract is a virtual company that operates based on the contract statutes that have been written in code. Anyone who decides to trade on a decentralized exchange accepts this contract and acts according to its established laws.

The smart contract is driven by the users themselves, but also by independent bodies that check the code of the contract for errors, such as companies that specialize in smart contract audits. In addition, any person can verify the contract because its code is public. However, this doesn't mean that every open contract can be considered safe. Not everybody understands the code, but the prospect of coding is substantial in contrast to the traditional banking system. Usually, a smart contract involves many thousands of participants, the actual number is open and increasing. In short, there will always be enough participants to keep the contract secure.

No one can deny you access to a decentralized exchange. As long as you have Internet access, you can trade within decentralized finance. There are no server downtimes or maintenance, nor are there even restrictions on access, due to collusion among exchanges on goods when limiting buying and selling to protect vested interests. These are true free markets!

Who determines the prices on a decentralized exchange?

Just like on centralized exchanges, prices on decentralized exchanges are determined by supply and demand. In addition, decentralized exchanges use so-called oracles. These are programmed portions of the contract that use the prices of the largest transactions as a guide. Prices across all exchanges (decentralized and centralized) may differ or fluctuate slightly. Since you decide where you want to trade, you can use arbitrage here. You may buy assets on one platform and sell them at a profit on another. This way, you take advantage of the fact that buyers cannot have an eye on all exchange prices, at all times. When prices are spiking or dipping, this creates a window of opportunity that you can take advantage of when investing. We offer you simultaneous access to several smart contracts so that you can make use of these opportunities.

How do supply and demand meet on exchanges?

In classical central exchanges, there is an order book in which all orders are listed. All buys and sells are brought together via this order book. Differences often arise here as well, which users take advantage of to generate profits. For example, if a buyer bids to pay a higher price than the seller, the difference is booked as a profit for the exchange. Often, the goods do not jump hands at all, because if the buyer and seller both remain on the exchange platform, the exchange can simply adjust the shift in its order book. Outflow only occurs when there is an actual withdrawal to another platform. This reconciliation is also used in decentralized exchanges, but technically it works completely differently.

How are buyers and sellers brought together on decentralized exchanges?

Just like on centralized exchanges, sellers and buyers are brought together by their orders at a specific price. Either the buyer buys at current prices or places an order at the desired price, which would be triggered when it is reached. To the outside world, the process looks the same to the user as on a central exchange. So, using it is just as easy.

What are the risks for you as a buyer/seller?

The contract offers you goods at their stated prices only if they are available. In contrast to centralized exchanges, the pool is openly visible. Technically, no values can be sold that are not available. In central exchanges, there have already been incidents with users buying goods that only existed in the exchange's book, without the true equivalent in existence. The size of actual reserves and collateral required by exchanges is regulated by the countries in which the exchanges operate. In highly regulated exchanges, the risk is very low. Nevertheless, the books must always be audited by external parties for accuracy. Theoretically, the exchange can use the funds of its users for its own business and, for example, give out loans. As long as not all users want to withdraw their capital at the same time, this shadow business is not even noticed.

This risk is eliminated with decentralized exchanges. The pool is publicly visible and cannot be manipulated. There is no risk; when you buy, a transfer to your account takes place immediately on the other side. There is no waiting time, the moment assets flow out of your account as an exchange, you immediately receive your purchased goods in real-time. In other words, trades are instantaneous.

How does a decentralized exchange work?

A decentralized exchange is comprised of a so-called liquidity pool, which contains the total value of all traded goods on the exchange. For the platform to have exchangeable goods that can be traded at all, participants other than the buyers and sellers provide this liquidity for trading.

Liquidity mining is carried out so that the prices of the individual goods are stable and correspond to the total market. For this purpose, a third party of the contract participants (the miners) provides their assets in trading pairs.

For example, if the Dollar is traded against Bitcoin (BTC-USD) on a decentralized exchange, a miner has previously put both assets in the pool in the same value. He puts 1000$ in the pool and its counterpart, Bitcoin (BTC), worth 1000$. The goal of the contract is always to maintain this balance.

Now, if a user sells Bitcoin on the DEX against dollars, he receives the Dollars e.g., from the miner's stock. In return, the pool receives more Bitcoin. Since there is an outflow of Dollars, the pool contains more Bitcoin than before.

Thus, for a swift period, between Dollars and Bitcoin, there is a price imbalance in the pool. This can be perceived when prices of BTC-USD fluctuate. This is because there is a little more Bitcoin in the pool and slightly fewer Dollars. Since the exchange is transparent with its prices, in a relatively short time, another trader will want to make up for this imbalance, as they can buy Bitcoin at a discount to restore the balance of $1000 in Dollars and Bitcoin for the pool.

So, the miner still owns a total of $2000 in assets. However, it now consists of slightly fewer Dollars than their initial deposit of $1000. In return, they now own more than the initial $1000 in Bitcoin.

In conclusion, the system regulates itself through suppliers, demanders, and miners