What are the benefits a decentralized exchange has over a centralized one?
Decentralization means that a user remains in full control of their funds at all times.
On a centralized exchange (CEX), transactions are facilitated by an intermediary, the platform itself.
By contrast, a decentralized exchange (DEX) enables users to transact directly. As a result, the platform doesn’t hold any funds, meaning they can be less susceptible to hacks.
In addition to security, DEXs have also proven to grant users access to a greater cross-section of cryptocurrencies.
Given how Bitcoin was founded to promote decentralization and disintermediate banks, some enthusiasts argue DEXs stay true to the core values of cryptocurrencies.
How do decentralized exchanges work?
DEX replaces order matching systems with autonomous protocols known as automated market makers.
In practice, a DEX replaces the traditional order matching systems with autonomous protocols such as an automated market maker (AMM). These protocols use smart contracts, a form of a self-executing computer program, to define the price of digital assets and provide liquidity. Under this model, users no longer trade directly with a counterparty. Instead, they trade against the liquidity held in smart contracts, also known as liquidity pools.
In each pool, other investors will provide liquidity by depositing funds in exchange for a passive earning opportunity.
What is an automated market maker?
An AMM is a protocol that guarantees liquidity on a DEX around the clock.
A market maker facilitates the process of providing liquidity for trading pairs on centralized exchanges. However, unlike CEX, a DEX eliminates the intermediate processes involved in crypto trading.
With DEXs, users can initiate trades directly from non-custodial wallets. In this sense, the AMM is the underlying protocol that enables DEXs to connect users without an intermediary but in a way that solves the previously existing liquidity problem. Therefore, instead of relying on traditional buyer and seller pairings in the financial market, an AMM can ensure DeFi liquidity at all times through liquidity pools.
What yield framing opportunities exist on AMMs?
Liquidity pools require enough funds to facilitate transactions.
Since these funds originate with platform users, they must be properly incentivized to provide them. The strategy named yield farming is often used for that. In many cases, investors have participated in different protocols. They have benefitted from high APRs upon joining a new project, with double digital rewards being common temporarily. Think of a bank that offers a 5% interest rate for new deposits.
In some cases, pools will offer liquidity provider tokens (LP tokens) in exchange for a user providing liquidity, which can later be traded for rewards or staked for additional earnings.
Where are today’s AMM-based DEXs falling short?
Avoiding slippage, poor infrastructure and lack of adequate incentivization to stake funds, among others.
Unfortunately, many initial AMM releases do not enable users to source liquidity and lack capital efficiency, and if they can, it is not in a trustless manner. For this reason, some have looked to aggregators to achieve the best prices for any token swap on supported networks.
Attracting liquidity is crucial to ensuring AMMs work properly since the more funds there are in the pool, the less slippage will occur in large orders, and the more users will be attracted to the platform.
As a result, many tools present high APRs as a marketing ploy to build communities. The caveat is that these numbers are often inorganic, with unsustainable incentives. In contrast, a good platform will work with partners as part of a more sustainable ecosystem that can guarantee high returns for the long term.
What are some of the best platforms available on the market today?
Modern exchanges are aggregating deeper liquidity to ensure sufficient funds in pools.
The number of modern platforms is rising, making it hard for a user to choose the most suitable option.
KyberSwap is one competitive DEX on the market, operating with the ability to aggregate liquidity from over 80 exchanges across 11 chains extending from Avalanche to Aurora. Working hand in hand with a Dynamic Trade Routing platform, traders are guaranteed optimal trade routes and prices with an algorithm that automatically splits trades across these exchanges.
The DEX also provides a Discover feature that utilizes TrueSight technology to analyze trading volumes and price trends, ensuring that investors take advantage of trending tokens as they arise.
On the liquidity side, KyberSwap provides additional incentivization for users to stake their funds through their liquidity mining program. Here, liquidity providers can earn bonus incentives by adding token liquidity and staking LP tokens to associated farms.
A new protocol called KyberSwap Elastic has just been unveiled too, which is a tick-based AMM offering concentrated liquidity. This gives users the flexibility to provide liquidity to pools with different fee tier settings, with earnings automatically reinvested so they benefit from compounding. An anti-sniping feature is also offered for added protection.
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