What is a DEX?

Written for Zapper Layer3 Bounty submission.

What is a DEX, and why is it important?

DEX stands for Decentralized Exchange. Decentralized exchanges have introduced a revolutionary way to swap tokens without requiring a centralized intermediary! Decentralized exchanges are one of the most critical innovations assisting in the growth of Web 3 today! Because of this innovation, Web 3 users do not need to depend on a centralized party to custody their tokens to swap them. Decentralized exchanges are genuine peer-to-peer exchanges that power Web 3!

Why are DEX’s important?

DEX’s are revolutionary because they provide a decentralized platform for exchanging assets. Before decentralized exchanges, token holder’s only option for swapping tokens was to transfer them off-chain to a centralized party.

With the addition of Decentralized exchanges, token holders can hold their tokens on-chain and swap if and when they want to! This addition truly is monumental for so many reasons, swapping tokens just being one of those reasons!

Decentralized exchanges opened the doors for an entirely new sector within Web 3, known as decentralized finance (DeFi)! Decentralized finance allows Web 3 users to have full custody of their tokens and participate in financial markets on chain! Defi encompasses the entire financial ecosystem within the blockchain, and decentralized exchanges are considered the heart that powers decentralized finance!

How do DEX’s Work?

The structure of a decentralized exchange depends on two roles.

The first is the liquidity provider, which deposits tokens into liquidity pools. Liquidity pools are a collection of deposited tokens that offer liquidity for other users to make swaps. These depositors earn a ‘swap’ fee, which the user pays with every exchange made. For example, let's say Person A has $50 worth of $USDC and $50 worth of ETH. This user can deposit both tokens into a USDC/ETH liquidity pool and earn a portion of swap fees every time somebody swaps $USDC for $ETH, or vice-versa! The swap fees incentivize token holders to provide liquidity, thus making the Decentralized exchange functional!

The second role is the swapper. Swappers represent the individuals who wish to swap one token for another token. An example of a swapper would be the individual in the example above wanting to exchange their $USDC for $ETH.

By using smart contracts, DeFi participants do not need to rely on a third party to hold their tokens to swap them! The entire ethos of cryptocurrency depends on decentralization and transparency. Decentralized exchanges offer a way for individuals to transact in a decentralized and transparent manner!

Diving into DEX’s

There are a lot of different DEX’s across many chains, all with different unique approaches to incentivizing liquidity providers and offering various unique ways to swap tokens. For a complete list of these exchanges, check out Defillama!

(Note: Always be sure to use caution while operating on-chain, as ‘being your own bank’ bears a lot of responsibility! Please educate yourself of all risks associated with using decentralized financial tools before using them!)

For more information on Decentralized Finance and Decentralized exchanges, check out Zapper Learn!