Decentralized Exchanges (DEX) Are Not Complicated: Understand the Two Main Operating Models in One Article

In the cryptocurrency trading ecosystem, DEX (Decentralized Exchange) is quietly changing the game rules. Compared to traditional centralized exchanges, DEX adopts permissionless and non-custodial mechanisms, allowing users to trade without KYC verification and opening up a brand new trading experience.

DEX stands for Decentralized Exchange, simply put, it is a trustless trading method. The biggest feature of such exchanges is that they are instant and seamless—users can connect their wallets directly to trade, complete exchanges, and do not need to register or log in. This level of freedom is almost unimaginable in traditional finance.

Why Choose DEX? A Trustless Trading Experience

Unlike centralized exchanges that require assets to be held on the platform, DEX allows each trader to truly control their own assets. This not only reduces the risk of theft or freezing but also embodies the core concept of blockchain’s “non-custodial” approach.

The development speed of DEX is accelerating. At certain times, the monthly trading volume of decentralized exchanges has surpassed $4 billion, accounting for nearly 4% of the trading volume of centralized exchanges, up from less than 2%. This shift proves a fact: more and more traders are starting to trust and use DEX.

When users trade on DEX, the flow of funds is transparent and visible, and all operations are recorded on the blockchain. This transparency makes the trading process safer and more reliable, eliminating the need to trust third-party exchanges.

Order Book vs. Liquidity Pool: Two Evolutionary Paths of DEX

The operation of DEX mainly falls into two categories, representing two different stages of this ecosystem.

First: Order Book DEX — The Traditional Model on Blockchain

Order book DEX uses an auction model similar to traditional stock exchanges. Buyers place buy orders, sellers place sell orders, and trades are completed by matching these instructions. Traders can submit two types of orders: limit orders (buy at a specified price for a certain amount of tokens) and market orders (immediate execution at the best available market price).

Projects like IDEX, EthFinex, and EtherDelta are representative. The advantage of this type of DEX is that when liquidity is sufficient, the spread loss for users is minimized. However, order book DEX requires a relatively high level of project participation—enough traders to create an active market.

Second: Liquidity Pool DEX — The Revolution in the DeFi Era

With the continuous emergence of DeFi tokens, the limitations of order book DEX have become apparent. Many new DeFi tokens lack sufficient traders to support them, and insufficient liquidity leads to volatile prices, which further discourages potential traders, creating a vicious cycle.

Thus, a new trading model has emerged—the Automated Market Maker (AMM) mechanism based on liquidity pools.

Anyone Can Become a Market Maker: The Democratization of AMM Design

Traditional market makers are professional traders who profit by buying and selling assets, creating liquidity, and reducing trading slippage. But in the blockchain era, this role has been “democratized.”

Automated Market Makers mimic the behavior of traditional market makers through algorithms. They do not specify buy or sell prices but instead pool funds into a liquidity pool and use predefined algorithms to quote prices for trading pairs. Simply put, they replace human pricing with mathematical formulas.

The most attractive aspect of this is: any user within the crypto community can become a liquidity provider. Users deposit a pair of tokens into the liquidity pool and earn transaction fees from each trade in the pool. This means DeFi enthusiasts can not only trade but also participate in the profit sharing of the exchange.

Each AMM exchange has its own algorithm parameters. This flexibility has led to various innovative models and created possibilities for different types of token trading.

Leading Players: Uniswap, Curve, and the Mainstream DEX Ecosystem

Uniswap is the leader in the DEX space, fully adopting the AMM model. Its success lies in allowing everyone to become liquidity providers and ensuring sufficient liquidity through carefully designed incentive mechanisms. The fees earned by users providing liquidity are their share of the trading activity on Uniswap.

Besides Uniswap, other innovators are exploring the evolution of AMM in the DEX ecosystem. Bancor was among the earliest to implement the AMM concept, Balancer optimized for multi-asset trading, and Curve specializes in providing the best trading curves for stablecoins.

These projects are innovating in real-time liquidity provision for the DeFi world. AMM not only has the advantages of traditional market makers but also inherently features security, reliability, no regional restrictions, and non-custodial operation.

A Trend to Watch

As DEX and DeFi deepen their integration, decentralized exchanges are on a fast track of development. Many industry insiders believe that DEX needs to continuously optimize user experience and lower participation barriers to better support the expansion of the DeFi ecosystem.

Once capital allocation efficiency improves and risk control mechanisms are perfected, the scale of funds in DeFi will experience explosive growth. As the infrastructure of the DeFi ecosystem, DEX will play an increasingly important role.

The best way to truly understand how DEX works is to experience it firsthand. In the wave of DeFi, try connecting your wallet and completing a decentralized trade. When you see funds instantly transfer from one token to another and return directly to your wallet, you’ll realize that the charm of blockchain is much simpler and more direct than you imagined.