The single most alluring concept about cryptocurrencies is decentralisation. True Bitcoin believers revel in the idea of a currency without centralised or government control. Decentralised exchanges (DEXes) and liquidity mining serve this end.
This fact makes cryptocurrencies endearing. No one can unilaterally decide to shut down Bitcoin. Subsectors like crypto gambling have gained popularity because users can wager using crypto. A gamer can bypass the bottlenecks of traditional payment systems by playing Bitcoin gambling games.
However, this industry has one enduring irony. The largest exchanges mostly rely on centralised operations. These exchanges can decide to lock out any user arbitrarily. Centralised exchanges dilute the concept of decentralisation and have significant power in the crypto industry.
Decentralised Exchanges (DEXes)
Centralised exchanges operate as middlemen for people transacting cryptocurrencies. Decentralised exchanges (DEXes) aim to get rid of this concept. In effect, users transact without a supervising third party.
DEXes make peer-to-peer swaps possible. These exchanges have their backend on the blockchain. Accordingly, users don’t entrust their funds to the exchange. Instead, the DEX works as a matching entity for transacting parties.
Decentralised exchanges can use on-chain smart contracts to achieve this end. Smart contracts are self-executing. This fact means that users don’t surrender custody of their funds at any point. DEXes have no supervisory role in the transaction, which is up to the parties.
There are decentralised exchanges that conduct cross-chain swaps. This role calls for off-chain order books. Therefore, such DEXes can take advantage of liquidity pools and relay orders between users. Off-chain order books give a DEX greater liquidity and usability for users. Some prominent off-chain order book DEXes include Binance DEX, IDEX, and EtherDelta.
Alternatively, a decentralised exchange can use the Automated Market Maker (AMM). AMM does not need makers and takers for trades. Specific AMMs have their implementation models. Generally, they string together smart contracts through the use of automation. Uniswap is one such DEX. Uniswap is more user-friendly, integrating wallets like MetaMask or Trust Wallet.
Decentralised exchanges are popular because they eliminate KYC and disclosure requirements. This possibility is useful for users who value privacy and the integrity of their information.
They also eliminate counterparty risk. Since a user does not surrender custody of their funds, it eliminates risks for exchange hacks. This advantage is vital in the crypto industry.
Unfortunately, decentralised exchanges have some shortcomings. Most struggle with high trading volumes and liquidity demands. Liquidity is a metric of how easy it is to purchase or sell assets at an exchange with reasonable prices.
For all their problems, Centralised exchanges enjoy a significant liquidity advantage. This liquidity issue has led to the rise of liquidity mining.
Liquidity Mining (Yield Farming)
The rise of Decentralized Finance (DeFi) has created liquidity solutions for DEXes.
Liquidity mining, otherwise known as yield farming, is an innovative way of providing liquidity for these exchanges. The model benefits both sides. DEXes have more liquidity, while liquidity providers earn some income.
Accordingly, the DEX provides incentives for users willing to bring capital to the platform. DeFi is a rapidly-growing industry with billions of dollars worth of assets in the startups. The use of AMMs makes liquidity mining work smoothly.
DEXes create liquidity pools to facilitate seamless decentralised transactions. Users can trade tokens within these liquidity pools. Each time a user trades, they pay a small fee.
The AMM uses these fees to reward liquidity providers. Therefore, an AMM liquidity pool creates a symbiotic relationship. Users can trade for tokens on a decentralised platform while liquidity providers earn rewards.
It operates like mining. In Bitcoin mining, a user provides computer hardware and earns rewards. For liquidity mining, the users put their funds into the liquidity pool and receive transaction rewards.
Liquidity pools aim to keep a stable ratio of respective assets. Accordingly, the liquidity pool must consist of an equal amount of both tokens. Liquidity miners often have to contribute equal amounts of token trading pairs. This way, commerce is possible for all kinds of users.
Decentralised exchanges still need community governance to maintain decentralisation. The entire point of having this model is to eliminate the role of a middleman. Different DEXes have enacted governance systems to maintain decentralisation. This necessity has created governance tokens for decentralised exchanges.
Decentralised exchanges (DEXes) are playing catch-up to their larger counterparts. For all their benefits, decentralised exchanges still lag in liquidity. Leading centralised exchanges have the liquidity to handle significant trades instantaneously.
Accordingly, they remain popular because they are more efficient. For this, leading online crypto gambling sites like BC.Game list the governance tokens of most DEXes, like Uniswap (UNI), as an example.
With liquidity mining, the decentralised exchange can scale up operations, offering more opportunities for token holders who may be involved in other income-generating activities like online gaming. DEXes can only favourably compete if they have excellent liquidity. The implementation of liquidity mining and governance tokens is making this possible.
Therefore, the success of present DEXes may further entrench decentralisation in the crypto industry. This ideal is indispensable in actualising the dreams of Bitcoin founder Satoshi Nakamoto. DEXes have a significant role in this mission.