Mechanism Analysis: decentralized exchange stage of the evolution of crypto trading

Key Points

• Users interact directly with DEX without intermediaries – this is not only a technological innovation but also a fundamental change in the distribution of power.
• The automated market making mechanism (AMM) completely breaks the traditional order book model, and liquidity pools make trading instant without waiting for a counterparty.
• Getting started with DEX is relatively complex, as users need to manage their own wallets, safeguard private keys, and understand basic concepts like gas fees, which pose a real challenge for beginners.

Two Paths of the Trading Market

Since the birth of Bitcoin, exchanges have been the bridge connecting supply and demand. Without these platforms gathering global users, the cryptocurrency market would have long been trapped in a liquidity crisis and pricing chaos. For a long time, centralized exchanges dominated the market. However, with the rapid advancement of blockchain technology, decentralized trading solutions have continuously emerged, becoming a strong complement to the market and even challengers.

What is DEX?

Decentralized Exchange is simply a platform that allows users to directly exchange digital assets with each other—without the need for a third party to oversee the transaction. In theory, any peer-to-peer asset swap can be referred to as a decentralized exchange. However, what we are discussing here is a decentralized platform that has the functional interface of a centralized exchange.

The core difference is that users always have absolute control over their funds. These platforms operate based on smart contracts, executing transactions automatically when conditions are met. In contrast, centralized exchanges act like banks, holding users' funds—your crypto assets are stored in their systems. In comparison, under the DEX model, assets are completely managed by you through the blockchain network.

Centralization and Decentralization: The Watershed of Operational Logic

How centralized exchanges operate ###

The traditional model is straightforward: users deposit fiat currency (bank transfers, credit cards, etc.) or cryptocurrencies, and then they can trade. However, there is a key issue here — while you can trade these assets, you technically do not control them. When you want to transfer funds elsewhere, you must submit a withdrawal request to the exchange, and you cannot hold the private keys. This means that every withdrawal requires the exchange to sign on your behalf.

When trading on a centralized exchange, the transaction itself does not involve on-chain operations. The exchange updates user balances in its own database. This system operates efficiently because transactions do not have to wait for blockchain confirmation; everything is completed within a central system. Cryptocurrency trading is convenient, with a wide range of tools and products provided by the platform. However, the price is that you must give up independence and entrust your funds to the platform, which itself is a risk commitment.

Another logic of decentralized exchanges

While DEX shares similarities with centralized exchanges, the differences are equally profound. First and foremost, it is important to clarify that decentralized exchanges are divided into several types. Their common feature is that orders are executed on-chain (via smart contracts), and users retain ownership of their assets throughout the process. Although there are cross-chain DEXs, the most popular ones operate within a single blockchain ecosystem (such as Ethereum or Binance Smart Chain).

On-Chain Order Book Model: Some DEXs place all operations on-chain—including orders, modifications, and cancellations. This is the most transparent method, as you don’t have to rely on any intermediaries. However, the cost is that you must pay gas fees to network nodes for each operation, and you have to wait for miners to package the data into blocks, which can often be time-consuming and expensive.

Off-chain Order Book Model: This solution was popular during the early DeFi wave but has gradually been phased out. These platforms, while claiming to be decentralized, store orders off-chain, typically managed by a centralized entity—significantly undermining decentralization attributes. Additionally, there are risks: the controlling party may manipulate the market through front-running or falsifying orders.

Automated Market Maker (AMM) Mode: This is the mainstream choice for DEXs. Unlike traditional order books, AMMs do not have the concept of buyers and sellers—only users, mathematical algorithms, and incentive mechanisms. Such platforms use liquidity pools instead of order books. Users inject crypto assets into the pools, and trading is priced according to preset formulas (like the famous x × y = k). Liquidity providers earn fees for contributing liquidity; they are the operators of the entire system.

What is the biggest advantage of this model? You can trade at any time without waiting for a specific buyer or seller to appear. Taking mainstream AMM platforms as an example, they determine prices through a constant formula, and liquidity providers profit from transaction fees. The specific implementation details of AMM vary, but they usually combine smart contracts and design incentive mechanisms to attract participation. Nowadays, AMM-based DEXs have been integrated into wallet applications, significantly enhancing user experience. However, executing trades still requires on-chain operations.

Major Players in the Market

After understanding the operation principle of DEX, let's take a look at specific mainstream products:

Mainstream AMM Platforms: These platforms are recognized for their ample liquidity, multi-chain support, and ease of use. They offer a convenient trading experience and are fully compatible with mainstream wallets.

Derivatives: Certain platforms innovate based on existing models, introducing governance token mechanisms, liquidity mining, and other new features to further attract user participation.

Public Chain Ecological Solutions: Many DEXs choose to deploy on public chains with lower costs, providing options for users seeking low fees.

What DEX Brings

Compared to centralized exchanges, the appeal of DEX lies in:

• True Self-Custody: Trade directly from your wallet, having complete control over your funds. No need to trust any intermediaries.
• Global Without Borders: Anyone with a crypto wallet and internet connection can participate.
• High Freedom of Listing: Tokens that have not been reviewed by centralized exchanges can be traded as long as there is sufficient liquidity.
• Highest Transparency: All transactions and operations are recorded on the blockchain, and anyone can verify them, resulting in zero trust costs.

The Real Dilemmas Facing DEX

The ideal is full, but the reality is skinny:

• Code Risk: DEX relies on smart contracts, and the contracts themselves are code. Any coding vulnerabilities could be exploited by hackers, leading to loss of funds.
• Liquidity Bottleneck: Small DEXs often lack sufficient liquidity, making it difficult to find trading counterparts, which may lead to significant slippage losses.
• High Learning Cost: Beginners are often intimidated by the complexity. Managing their own wallets, properly securing mnemonic phrases, understanding gas fees and blockchain principles—these barriers are much more complex than logging into an account for trading.
• Transaction Front-Running: Once your transaction is submitted, others can see it before it is confirmed. Transactions with higher fees may be executed first, resulting in worse pricing for your transaction.
• Fee Pressure: Gas fees can be exorbitant depending on the congestion level of the blockchain, especially during peak network times.

The Future Vision of Decentralized Trading

With the maturity of second-layer scaling solutions (such as rollups and sidechains), DEX trading will become faster and cheaper. At the same time, the decentralized autonomous organization (DAO) model is on the rise. More and more DEX platforms are launching governance tokens, allowing users to participate in decision-making through voting. This decentralizes power to the community.

Cross-chain trading is another cutting-edge direction. Although still in its early stages, it holds the promise of making DEX more versatile, allowing users to seamlessly trade assets across different blockchains.

Final Thoughts

DEX is redefining the landscape of cryptocurrency trading. As a powerful alternative to centralized exchanges, they gain appeal by eliminating intermediaries, giving users control over their funds, and providing access to global finance. While DEX still faces many challenges, the outlook is promising. An increasing number of users are flocking to the decentralized finance space, and DEX is sure to play an increasingly important role in the trading and management of digital assets.

If you are interested in decentralized trading, DEX is worth exploring. But remember: do thorough research, properly secure your private keys, and always be vigilant about risks.