What is a DEX | Understanding Decentralized Exchanges

This page is about the Decentralized Exchange (DEX)is an informational piece of content that makes it easy to understand what decentralized exchanges are and how they work.

Table of Contents

What is a DEX?

A DEX is a cryptocurrency exchange that allows direct trading between users without a centralized authority. Blockchain-based trading platformis the value.
A typical example is Uniswap, PancakeSwap, SushiSwap and more, and you can start trading right away by simply connecting your wallet, no signup required.

💡 It's a 'wallet-to-wallet exchange' that allows you to swap coins instantly by connecting your wallet, no email signup required.

How does it work?

Most DEXs use the Automated Market Maker (AMM) method.
Users deposit coins into a space called a "liquidity pool," and transactions are executed based on an automatically calculated price based on this pool.
With each transaction, the percentage composition of the pool changes and the price adjusts automatically.

💡 It automatically calculates and exchanges from a pool of coins that people put in.

Easily understand with examples

For example, let's say 1 BTC is worth 20,000 USDT.

User A deposits 1 BTC + 20,000 USDT into the liquidity pool.

→ Liquidity pools totaling $20,000 in value created
User B buys BTC with 2,000 USDT.

→ You will receive approximately 0.091 BTC based on the AMM formula
As the amount of BTC in the pool decreases and the amount of USDT increases

→ BTC price will automatically increase
When another user deposits BTC

→ Conversely, BTC goes up, USDT goes down, and the price readjusts

💡 It's automatically designed to increase in price when someone buys a lot and decrease in price when they sell.

Examples based on price changes

When BTC doubled

Initial: Deposit 1 BTC + 20,000 USDT (total value of $40,000)
BTC price doubles → external quotes 1 BTC = 40,000 USDT
When the price is reflected through the swap, my asset will be

→ Approx. 0.5858 BTC + 23,313.7 USDT (auto-adjusted rate)
At that point, the total value of the assets is approximately 46,627.4 USDT
But if you just held on to it, you'd have 1 BTC (40,000 USDT) + 20,000 USDT → 60,000 USDT total
→ Approximately 13,372.6 USDT difference from holding (excluding fees)

When BTC fell to half price

Initial: Deposit 1 BTC + 20,000 USDT (total value of $40,000)
BTC price doubles → external quotes 1 BTC = 10,000 USDT
When the price is reflected through the swap, my asset will be

→ Approx. 1.4142 BTC + 14,142.13 USDT (auto-adjusted rate)
At that point, the total value of the assets is approximately 28,284.27 USDT
But if you just held on to it, you'd have 1 BTC (10,000 USDT) + 20,000 USDT → 30,000 USDT total
→ Approximately 1,715.73 USDT difference from holding (excluding fees)

What happens to my assets when I withdraw?

Liquidity providers can withdraw their deposited assets at any time.
However, the asset composition at the time of withdrawal may be different from the time of deposit. Example: 1 BTC + 20,000 USDT at the time of deposit → 0.95 BTC + 21,000 USDT at the time of withdrawal

This is because the transaction changes the ratio within the liquidity pool, and the Transaction feesas a reward.

💡 It's 1:1 when you add it, but the ratio can change when you take it away. I get paid in commissions.

Can I lose money?

Impermanent Lossconcept.
If the price of one of your deposited coins goes up or down significantly, you could make less money than if you just held it.
However, if you have a high volume of transactions, the fee revenue can offset this.

💡 If the price moves significantly, it can be a loss, but it can also be compensated by commission income.

Who can participate?

Anyone with a wallet can join.
Connect wallets such as MetaMask, Clip, Phantom, and others to exchange coins or monetize by providing liquidity.
It is characterized by no KYC verification and no account creation.

Top DEX platforms

Uniswap: Largest DEX on Ethereum
PancakeSwap: Binance Smart Chain (BSC) Main DEX
SushiSwap: Multichain-enabled DEXs
Bucksdex: Coming soon, a DEX powered by the BugsCoin ecosystem

What's the difference between a DEX and a CEX?

A centralized exchange (CEX) is an exchange run by a central server, like Binance and Upbit.
A DEX, on the other hand, is a cryptocurrency exchange where all transactions are done through smart contracts. Decentralized exchangesAnswer.

Item	DEX	CEX
Sign up	You only need to connect your wallet to use it	Email and KYC required
Asset custody	Store directly in your personal wallet	Entrusting assets to an exchange wallet
How to trade	AMM method (liquidity pool-based)	Order book method (price matching)
Security	Beware of personal wallet hacks	Risk of central server hacking

💡 Instead of managing assets themselves, DEXs make it harder to recover from mistakes and can cost you gas money.

💡 CEX is easy to use, but it relies on a centralized system.

Viewing the DEX from a user and provider perspective

As a user (trader)

Just connect your wallet and start trading immediately
I own my own assets
Gas fees may apply, speeds vary by chain

💡 You can save on fees by managing your own assets, but it can be slow or expensive when the chain is congested.

Provider Position (LP: Liquidity Provider)

Deposit two coins to enable trading
Earn a share of transaction fees
Possible permanent loss

💡 You can expect to earn fees, but you can also lose money if the price of the coins you deposited changes significantly.

What is a Gas Fee?

For all activity on the DEX, including trading, deposits, withdrawals, etc. Gas costsis raised.
These are fees for using the blockchain network, with Ethereum being relatively expensive and BSC, Polygon, etc. being cheaper.

💡 Since all operations are executed on the blockchain, gas costs must be considered when using a DEX.

What is a Bridge?

The ability to move assets between different blockchains Bridges.
For example, if you want to move USDT on the Ethereum chain to BSC, you'll need to use a bridge.

Using bridges incurs a small gas fee and can introduce transmission latency.

💡 DEXs can only trade within the same chain, so you need to use bridges to cross chains.

Wrapping up

DEXs are an uncomplicated way for anyone to participate in the Decentralized exchangesis the value.
You hold the assets yourself, transactions are automatically executed by smart contracts, and you can even monetize them by providing liquidity.
It works on completely different principles than a centralized exchange, so understanding and using its structure is paramount.
💡 If you're new to it, we recommend starting with a small amount on a chain with low gas fees (BSC, Polygon, etc.).
💡 When connecting a wallet, make sure to check the official URL, and when using bridges or swaps, make sure to check the fees and chain information.

New technologies can feel intimidating, but once you understand them and experience them piece by piece, they're much simpler and more intuitive than you might think.