Dex, short for Decentralized Exchange, refers to a decentralized trading platform.

As we all know, in traditional finance, if you want to buy stocks like Alibaba or Tencent, you need to go to a U.S. stock exchange. Similarly, if you want to buy digital assets like Bitcoin or Ethereum, you need to go to a corresponding digital currency exchange. Dex is the digital currency exchange’s counterpart in the DeFi world. By using smart contracts and on-chain transactions, it bypasses the need for third-party institutions, fulfills the function of matching trades, and ensures fairness and transparency in transactions.

Below, we’ll specifically discuss the differences between traditional digital currency exchanges and DEXs:

In traditional digital currency markets, when users trade, they place many buy and sell orders. The exchange is a platform provided by a third-party team that matches these buy and sell orders to help users complete transactions. Throughout this process, users’ assets are held and managed by the exchange.

Over time, this has led to a new problem: people feel that exchanges operate like black boxes, with opaque data, making it unclear whether they actually hold sufficient reserves. As a result, some proposed replacing the original third-party trading platforms with smart contracts written in code to perform the trade-matching function, giving rise to decentralized exchanges.

However, traditional exchanges, in the process of matching user trades, often rely on professional market-making teams to ensure order book depth for buyers and sellers, maintaining stable and smooth transactions. Decentralized exchanges, lacking third-party market makers, result in large spreads between user trades. For example, an asset with a market price of $100 might not have any sellers at $100 due to insufficient order depth, forcing buyers to raise the price to $200 to execute the trade. This means users lose money before even trading.

To solve this problem, decentralized exchanges introduced a special mechanism—the liquidity pool. This pool acts like a reserve pool for the decentralized exchange, where users deposit funds upfront, and all subsequent trades exchange digital assets through this pool. The pool provides order depth, ensuring transactional stability.

Additionally, the funds in this pool can be provided by anyone, without restrictions, and can be withdrawn at any time. Decentralized exchanges also reward liquidity providers with a portion of the transaction fees as an incentive, encouraging participation in liquidity provision. Thus, compared to traditional centralized exchanges, decentralized exchanges rely on collective "market-making" by users to maintain trading stability and depth.

In summary, both centralized and decentralized exchanges have their advantages. Decentralized exchanges offer greater transparency and fairness in rules, while centralized exchanges provide faster efficiency and a better user experience. It’s believed that for a long time to come, the two will complement each other, competing and cooperating to deliver a better financial investment experience.