Decentralized Exchanges Explained: How To Use A DEX

Decentralized exchanges or DEXs, have become one of the largest avenues for crypto trading in recent bull markets. These platforms give users more control over their funds, and allows trading newer and more diverse tokens that might not be listed on centralized exchanges like Binance or Coinbase.

According to CoinGecko data, DEXs currently facilitate over $1.4billion daily trading volume. As the popularity of these platforms continues to rise and the next bull market is potentially around the corner, it’s the perfect time to learn about trading on decentralized exchanges. Here’s our detailed guide:

Key takeaways

• DEXs operate through smart contracts and liquidity pools, allowing users to trade directly from their wallets without intermediaries. Automated Market Makers (AMMs) set token prices based on supply and demand in the pool.
• To trade on a DEX, you connect a compatible crypto wallet (like MetaMask or Trust Wallet) to the DEX, enabling secure, peer-to-peer transactions.
• Choose a token pair, review fees and slippage, and confirm the swap. The DEX’s smart contract completes the transaction on the blockchain, transferring tokens directly to your wallet.

Quick look: What is a DEX (decentralized exchange)?

A decentralized exchange allows users to trade digital assets without relying on a central authority or intermediary. Transactions occur directly between users, utilizing blockchain technology to provide transparency and security. DEXs operate through smart contracts that enable trades automatically and manage funds without third-party intervention.

So, what does a DEX do? Unlike centralized exchanges, DEXs don’t require users to deposit assets into exchange-controlled wallets, reducing risks associated with custody and data breaches. DEXs often adopt AMMs, which use liquidity pools to match trades or order book models similar to traditional exchanges.

Examples include Uniswap, PancakeSwap, and SushiSwap, each offering unique features but adhering to the same decentralized principles.

How does a DEX work?

A decentralized exchange works by executing trades through smart contracts on a blockchain, eliminating the need for intermediaries. Here’s a technical breakdown of how it functions:

1. AMMs

Most DEXs, like Uniswap and SushiSwap, use an AMM model rather than a traditional order book. AMMs rely on liquidity pools, where users supply pairs of tokens (e.g., ETH/USDT) to create a market.

This setup enables the system to maintain liquidity and match trades without relying on buyers and sellers directly. The constant product formula — x * y = k, where x and y represent token quantities and k remains constant — governs these pools, adjusting prices dynamically as trades occur.

Example: If someone swaps ETH for USDT, the smart contract will reduce the ETH in the pool and increase the USDT, automatically adjusting the price based on the pool’s balance.

2. Order book DEXs

Some DEXs, such as dYdX or Loopring, use an order book model similar to centralized exchanges. These exchanges maintain lists of buy and sell orders, matched by price. Order book DEXs still rely on smart contracts, but their architecture often includes layer 2 solutions to handle high transaction speeds and reduce blockchain fees. Order book DEXs are more suited to high-frequency and professional trading.

Example: When a user submits a limit order to buy BTC on a DEX like dYdX, the smart contract places this order in the order book, matching it with sellers at the specified price. If there’s no immediate match, the order remains until it is filled or canceled.

3. Liquidity providers (LPs)

In AMM-based DEXs, liquidity providers supply tokens to liquidity pools, earning a share of transaction fees for their contributions. This model incentivizes users to provide liquidity, keeping the DEX operational. Liquidity providers receive LP tokens, representing their share in the pool, which can be redeemed to reclaim their assets along with a portion of the accumulated fees.

Example: If you add ETH and USDT to a Uniswap pool, you receive LP tokens representing your share. These tokens accrue value as other users swap between ETH and USDT, generating fees.

4. Fees structure on DEXs

Unlike centralized exchanges, DEX fees vary based on protocol and trade volume. Most DEXs charge a flat fee per transaction rather than variable percentages based on account levels or trading tiers.

• AMM fees: Typically, AMM-based DEXs charge a fixed percentage (e.g., 0.3% per trade on Uniswap). This fee goes to liquidity providers, rewarding them for maintaining the pool’s liquidity.
• Gas fees: Transactions on a DEX also incur blockchain gas fees. On Ethereum, these fees fluctuate with network congestion and cover costs for validating trades on the blockchain. Some DEXs, like those built on Binance Smart Chain (BSC), offer lower gas fees due to the network’s efficiency.

Using a DEX, a trader pays two main fees: the swap fee (fixed) and the blockchain gas fee (variable). For small trades, gas fees can exceed the swap fees, making DEXs less economical on networks with high gas costs, like Ethereum.

Layer 2 solutions and alternative blockchains (e.g., Polygon, BSC) help lower these costs, making DEXs more accessible for all trading volumes.

Example: On Uniswap, a trader swapping ETH to USDT pays a 0.3% swap fee to LPs and a gas fee, which could vary significantly based on Ethereum’s network traffic. In contrast, trading on a DEX on BSC might have a similar 0.3% fee, but the gas costs would be lower, making it more attractive for frequent or smaller trades.

How to use a DEX: What you need to know

Here’s a beginner-friendly, step-by-step guide on how to use a DEX effectively, covering everything from selecting the right DEX to completing a transaction.

Step 1: Find a good DEX

When choosing a DEX, look for security, reputation, and supported cryptocurrencies. Decentralized exchanges like Uniswap, PancakeSwap, and dYdX each serve different needs. Uniswap operates on Ethereum, while PancakeSwap runs on Binance Smart Chain, offering lower fees. dYdX, on the other hand, specializes in order book trading for more advanced options. Make sure the DEX you select supports the cryptocurrency pair you want to trade and has active liquidity to avoid high slippage.

Step 2: Have a crypto wallet

To use a decentralized exchange, you need a compatible crypto wallet. A crypto wallet is essential because it stores your tokens and connects directly with the DEX, allowing you to trade securely. Popular options include MetaMask for Ethereum-based DEXs and Trust Wallet for Binance Smart Chain DEXs.

After selecting a wallet, download the app or browser extension. Follow the setup instructions, then safely store your recovery phrase — you’ll need it to recover your wallet if you lose access.

Step 3: Fund your wallet

Once your wallet is ready, add funds. Buy cryptocurrency on a centralized exchange like Coinbase, Binance, or Kraken. After purchasing, transfer the cryptocurrency to your wallet using the wallet address found in the wallet app. Ensure you choose the correct network for transfers (e.g., Ethereum for Uniswap, BSC for PancakeSwap) to avoid losing funds.

Step 4: Connect wallet to the DEX

Go to the DEX website and connect your wallet. Look for the ‘Connect Wallet’ button, usually at the top of the DEX page. Select your wallet type (MetaMask, Trust Wallet, etc.) and approve the connection. This step links your wallet with the DEX so you can trade directly from your funds.

Using a DEX lets you trade cryptocurrencies directly, keeping control of your assets. Here’s a beginner-friendly, step-by-step guide on how to use a DEX effectively, covering everything from selecting the right DEX to completing a transaction.

Step 1: Find a good dEX

When choosing a DEX, look for security, reputation, and supported cryptocurrencies. Decentralized exchanges like Uniswap, PancakeSwap, and dYdX each serve different needs. Uniswap operates on Ethereum, while PancakeSwap runs on Binance Smart Chain, offering lower fees. dYdX, on the other hand, specializes in order book trading for more advanced options. Make sure the DEX you select supports the cryptocurrency pair you want to trade and has active liquidity to avoid high slippage.

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Step 2: Have a cryptocurrency wallet

To use a decentralized exchange, you need a compatible crypto wallet. A crypto wallet is essential because it stores your tokens and connects directly with the DEX, allowing you to trade securely. Popular options include MetaMask for Ethereum-based DEXs and Trust Wallet for Binance Smart Chain DEXs.

After selecting a wallet, download the app or browser extension. Follow the setup instructions, then safely store your recovery phrase — you’ll need it to recover your wallet if you lose access.

Step 3: Fund your wallet

Once your wallet is ready, add funds. Buy cryptocurrency on a centralized exchange like Coinbase, Binance, or Kraken. After purchasing, transfer the cryptocurrency to your wallet using the wallet address found in the wallet app. Ensure you choose the correct network for transfers (e.g., Ethereum for Uniswap, BSC for PancakeSwap) to avoid losing funds.

Step 4: Connect wallet to the DEX

Go to the DEX website and connect your wallet. Look for the ‘Connect Wallet’ button, usually at the top of the DEX page. Select your wallet type (MetaMask, Trust Wallet, etc.) and approve the connection. This step links your wallet with the DEX so you can trade directly from your funds.

Step 5: Choose a cryptocurrency pair

After connecting, pick the cryptocurrency pair you want to trade. If you want to swap ETH for USDT on Uniswap, select ‘ETH’ as the token you want to exchange and ‘USDT’ as the token you want to receive. Make sure you have enough of the initial cryptocurrency in your wallet to cover the trade and fees.

Step 6: Review fees and slippage

Fees vary by DEX and network. Gas fees (transaction fees) are generally higher on Ethereum-based DEXs but lower on Binance Smart Chain or Polygon. Always check the estimated slippage — the difference between expected and actual price due to market volatility. Many DEXs allow you to adjust slippage tolerance to avoid large price changes during your trade.

Step 7: Confirm the trade

Once everything looks good, confirm the trade. Click the ‘Swap’ or ‘Exchange’ button, then approve the transaction in your wallet. After confirming, the DEX processes the trade through smart contracts on the blockchain. The transaction might take a few seconds to a few minutes, depending on network speed and fees.

Step 8: Check your wallet for the new tokens

After the trade completes, check your wallet for the new tokens. If they don’t appear immediately, refresh the app or add the token’s contract address (available on sites like CoinMarketCap) to your wallet manually.

Final tips

• Double-check all wallet addresses and tokens before sending.
• Use trusted DEXs and never share your private keys.
• Watch for gas fees; high fees can make small trades expensive.

DEX vs CEX: What’s the catch?

DEX main feature is ‘Swap’: How does it work?

The primary feature of most decentralized exchanges is the ‘Swap’ function, which allows users to exchange one cryptocurrency for another directly from their wallet. As previously discussed, swap works through AMMs or liquidity pools.

To initiate a swap, a user:

• Connects their crypto wallet (like MetaMask) to the DEX.
• Selects the tokens they want to exchange (e.g., swapping ETH for USDT).
• Confirms the swap and approves the transaction in their wallet.

Since prices adjust with each trade, slippage — the difference between the expected price and the actual price received — can occur. Many DEXs allow users to set a slippage tolerance to prevent trades from executing if the price deviates too much from the expected rate.

DEX pros and cons listed

Benefits of decentralized exchanges (DEXs)

1. User control: Users maintain control over their funds, as DEXs use non-custodial wallets, reducing risks associated with centralized fund storage.
2. Privacy: DEXs typically don’t require KYC, enabling more private and pseudonymous trading.
3. Global access: With no registration requirements, DEXs provide unrestricted access, allowing anyone with a crypto wallet to trade.
4. Transparency: Every transaction on a DEX is recorded on a public blockchain, ensuring high transparency and auditability.

Risks of decentralized exchanges (DEXs)

1. Limited liquidity: Smaller trading volumes and limited liquidity pools can lead to higher slippage, particularly for less popular tokens.
2. Smart contract vulnerabilities: DEXs rely on smart contracts, which can be exploited if flawed, posing a risk to funds.
3. High fees on certain networks: On networks like Ethereum, high gas fees can make small trades costly, limiting accessibility.
4. Limited order types: Most DEXs lack advanced order types, like stop-loss, which are essential for certain trading strategies.

1. 01.

   What is the fee for using a DEX?

   

   Fees on a DEX typically include a trading fee (around 0.3% per trade, depending on the platform) paid to liquidity providers, plus network gas fees. Gas fees vary based on blockchain traffic, often higher on Ethereum but lower on networks like Binance Smart Chain.

2. 02.

   Are decentralized exchanges better than centralized exchanges?

   

   Decentralized exchanges provide greater control, privacy, and transparency by enabling peer-to-peer trading without intermediaries. However, centralized exchanges often offer higher liquidity, advanced order types, and faster speeds. Which is better depends on your priorities — security and privacy vs. convenience and liquidity.

3. 03.

   What are automated market makers (AMMs)?

   

   Automated Market Makers (AMMs) are smart contract protocols that allow users to trade assets on a DEX without traditional buyers and sellers. AMMs use liquidity pools and mathematical formulas to determine prices and maintain liquidity automatically.