Welcome to Module 4 - Course 2 of Mission Web3!
Join us as we learn how to buy and trade on Decentralized Exchanges.
Trading On DEXs
On Decentralized Exchanges (DEXs), trading works differently compared to traditional centralized exchanges.
Here's how trading works on DEXs:
No Intermediaries: DEXs operate on blockchain technology, which means there is no central authority or intermediary controlling the exchange. Users directly interact with the smart contracts powering the DEX.
Wallet Integration: To trade on a DEX, users need to connect their digital wallets (such as Uniswap) to the exchange. This allows them to securely manage their funds and interact with the DEX smart contracts.
Order Book vs. Automated Market Maker (AMM): There are two common types of DEXs. Some DEXs use an order book model, where buyers and sellers place orders that are matched by the exchange. Other DEXs use an AMM model, where liquidity pools are used to facilitate trades automatically based on predefined algorithms.
Order Book Model Example
Loopring is a protocol and platform that provides a DEX solution using the order book model. It's built on the Ethereum blockchain and aims to enhance trading efficiency, reduce costs, and increase liquidity for users.
Loopring's DEX operates by matching buy and sell orders on its order book. Users can place limit orders with specific prices they are willing to buy or sell at, and these orders are stored in the order book until they are matched.
Loopring also incorporates a concept called "off-chain order matching" to enhance scalability and minimize the costs associated with on-chain transactions.
Automated Market Maker Example
Uniswap allows users to trade various Ethereum-based tokens directly from their wallets without the need for intermediaries.
The DEX is built on top of the Uniswap Protocol, one of the most battle-tested decentralized, permissionless protocols. It uses a fixed algorithm to determine exchange rates and aggregates liquidity that allow people to trade.
Users can provide liquidity to these pools by depositing pairs of tokens, and in return, they earn fees for providing that liquidity.
Uniswap's AMM model has played a significant role in the growth of decentralized finance (DeFi) by enabling users to swap tokens, provide liquidity, and earn rewards based on their participation in the liquidity pools.
Liquidity Pools: In an AMM-based DEX, liquidity is provided by users who deposit their funds into liquidity pools. These pools consist of different cryptocurrency pairs, and users are incentivized with trading fees to provide liquidity.
Trading Pairs: AMMs can provide access to a much larger variety of trading pairs due to the permissionless nature of pool creation. Uniswap's Universal Router enables users to swap between any two tokens, even if there isn't a liquidity pool for that pair. It does this by swapping token through intermediary pools.
Decentralized Order Execution: When you place a trade on a DEX, it's executed through a smart contract. This means the trade occurs directly between your wallet and the liquidity pool, ensuring a trustless and decentralized process.
Transaction Fees (Gas Fees): Like any on-chain transaction, trading on DEX requires paying gas fees to the network for processing your trade.
Immutability and Transparency: All trades on DEX are recorded on the blockchain, making them transparent and immutable. Once a trade is executed, it cannot be altered or removed. Since there’s no central authority and all transactions are final, you can’t call the DEX up and revert the action. You are in control, that’s why it’s always important to do your own research and understand the trades you are making.
Trading on DEX empowers users to take control of their assets and participate in a more decentralized financial ecosystem.