What is a decentralized exchange (DEX)?

A decentralized exchange, or DEX, is a trading venue that runs as software on a blockchain. People swap one crypto token for another directly from their own wallets. No company takes custody of the funds, and no account is needed.

How does a DEX work?

A user opens the exchange's website, connects a crypto wallet and picks the two tokens to swap. The wallet asks the user to approve the trade. A smart contract, which is a program stored on the blockchain, then carries it out and sends the new tokens back to the same wallet.

Most DEXs do not match buyers with sellers. They use an automated market maker, a formula that quotes a price based on the balance of tokens sitting in a liquidity pool. The trader swaps against the pool, and the people who funded the pool earn a fee.

Uniswap, launched on Ethereum in November 2018, made this design popular. Similar exchanges now run on most blockchains that support smart contracts.

How is a DEX different from a regular exchange?

A centralized crypto exchange, such as Coinbase or Binance, is a company. It opens accounts, checks identity, holds customers' coins and decides which tokens to list. It can freeze an account, and it can also help when something goes wrong.

A DEX does none of that. Anyone can trade, and anyone can create a market for any token. The user keeps custody throughout. A DEX also deals only in crypto, so a user needs to own some already. It cannot take a bank transfer.

Supporters see this as trading without gatekeepers. Critics note that the lack of identity checks attracts fraud and money laundering, and that the legal status of these venues is still being worked out in several countries.

What is slippage?

Slippage is the gap between the price quoted and the price actually received. It happens because a trade changes the balance of the pool as it goes through. The larger the trade compared with the pool, the bigger the gap.

Wallets let users set a slippage limit, and the trade is cancelled if the price moves past it. Automated trading programs also watch for large pending swaps and trade just ahead of them, which can leave the user with a worse price.

Every swap also costs a network fee, known as a gas fee, whether or not the trade turns out well.

What are the risks?

• Fake tokens. A token on a DEX can carry the same name as a famous one and be worthless.
• Copycat sites. Scammers build lookalike exchange pages that ask the wallet to sign away its contents. See phishing and wallet drainers.
• Code bugs. A flaw in the exchange's contracts can put pooled funds at risk.
• No help desk. A mistaken swap cannot be reversed.