Key Takeaways

DEXs let users trade cryptocurrencies directly from their wallets, maintaining full control of their assets.

AMMs, such as Uniswap, replace traditional order books with liquidity pools. This system allows users to trade instantly without the need to match buyers and sellers, making decentralized trading more efficient and accessible.

Decentralized exchanges can be a bit trickier to get the hang of, especially for beginners. You need to manage your own wallet, keep your seed phrase safe, and understand how gas fees and blockchains work.

Introduction

From the early days of Bitcoin, exchanges have played a vital role in matching cryptocurrency buyers with sellers. Without these forums attracting a global user base, we’d have much poorer liquidity and no way to agree on the price of assets.

Traditionally, centralized players have dominated this field. However, with the rapidly evolving stack of technologies available, a growing number of tools for decentralized trades have emerged.

In this article, we’ll take a dive into decentralized exchanges (DEXs), trading venues where no intermediaries are required.

What Is a DEX?

A decentralized exchange (DEX) is a crypto trading platform where you can trade digital assets directly with others, without the need for an intermediary. In theory, any peer-to-peer swapping could constitute a decentralized trade. But in this article, we’re primarily interested in a platform that emulates the core functions of centralized exchanges.

Unlike centralized exchanges, DEXs allow you to hold full control of your funds. It's all powered by smart contracts, which automatically execute trades based on certain conditions.

When you use a centralized exchange, you're trusting the company to handle your crypto, much like a bank does with your money. With DEXs, no one’s holding your assets for you. Instead, you’re interacting directly with other traders through the blockchain network.

CEX vs. DEX

How a centralized exchange (CEX) works

With your typical centralized exchange, you deposit your money – either fiat (via bank transfer or credit/debit card) or cryptocurrency. When you deposit crypto, you give up control of it. Not from a usability standpoint, as you can still trade it, but from a technical standpoint. You have to withdraw your funds if you want to use it somewhere else.

You don’t own the private keys to the funds, which means that when you withdraw, you ask the exchange to sign a transaction on your behalf. When you’re trading on a CEX, transactions don’t occur on-chain. Instead, the exchange allocates balances to users in its own database.

The general workflow is incredibly streamlined on a CEX because the trades don’t have to rely on blockchain confirmations, and everything occurs in a single entity’s system. Cryptocurrencies are easier to buy and sell, and you have more products and tools available to you.

This does come at the cost of independence: you need to trust the exchange with your money. As a result, you expose yourself to some counterparty risk. What if the team runs off with your hard-earned BTC? What if a hacker cripples the system and drains the funds?

For many users, this is an acceptable level of risk. Especially if they stick to reputable exchanges with strong track records and precautions that mitigate data breaches and prevent financial crime.

How a decentralized exchange (DEX) works

DEXs are similar to their centralized counterparts in some ways but significantly different in others. Let’s first note that there are a few different types of decentralized exchanges available to users. The common theme among them is that orders are executed on-chain (with smart contracts) and that users do not sacrifice custody of their funds at any point.

Some work has been done on cross-chain DEXs, but the most popular ones revolve around assets on a single blockchain (such as Ethereum or BNB Chain).

On-chain order books

In some decentralized exchanges, everything is done on-chain (we’ll talk about hybridized approaches shortly). Every order (as well as alteration and cancellation) is written to the blockchain. This is arguably the most transparent approach, as you’re not trusting a third party to relay the orders to you, and there’s no way to obfuscate them. 

Unfortunately, it’s also the most impractical. Since you’re asking every node on the network to record the order forever, you end up paying a fee. You need to wait until a miner adds your message to the blockchain, meaning the experience can be cumbersome, too.

Off-chain order books

Off-chain order book DEXs were more common in the early days of DeFi but have since been replaced by other alternatives. They could still be considered decentralized in some regards, but instead of every order being posted to the blockchain, they were hosted somewhere else.

For instance, you could have a centralized entity completely in charge of the order book, which made them “less decentralized” than the other types of DEXs. This model also introduced some risks. If the entity in charge was malicious, they could game the markets to an extent (i.e., by frontrunning or misrepresenting orders).

Automated market makers (AMM)

The automated market maker (AMM) model does away with the idea of order books. It doesn’t require makers or takers, just users, game theory, and a bit of formulaic magic. 

This is the more popular option in the DEX world right now. Instead of an order book, AMMs use something called liquidity pools. These pools are created when users deposit their crypto into a shared pool, and trades are made based on a formula that sets the price. The advantage? You can trade at any time without waiting for a buyer or seller to match your order.

For example, Uniswap, one of the most well-known AMMs, uses a constant product formula (x * y = k) to determine prices. Liquidity providers earn fees by contributing to these pools, which keeps the system running.

The specifics of AMMs depend on the implementation. Generally, they string together a bunch of smart contracts and offer clever incentives to ensure user participation.

The available AMM-based DEXs today tend to be relatively user-friendly, integrating with wallets like MetaMask or Trust Wallet. As with other forms of DEXs, though, an on-chain transaction must be made to settle trades.

Popular DEXs

Now that we’ve talked about how DEXs work, let’s highlight some of the big players:

Uniswap: Uniswap is a popular AMM that makes trading easy and decentralized. Its liquidity pool model, multi-chain support, and ease of use have made it one of the most popular DEXs.

SushiSwap: Originally a fork of Uniswap, SushiSwap expanded on the original model by introducing additional features such as governance tokens and liquidity mining rewards, attracting users with its unique incentives.

PancakeSwap: Built on the BNB Smart Chain (BSC), PancakeSwap is known for its low fees compared to Ethereum-based DEXs, making it a popular choice for all types of users.

Benefits of Using a DEX

DEXs offer some interesting advantages over centralized exchanges:

Self custody: You can connect and trade directly from your wallet, with full control of your funds. There is no need to trust someone else to manage your funds.

Global access: Anyone with a crypto wallet and internet connection can use a DEX.

Unlisted tokens: Tokens that aren’t listed on centralized exchanges can still be traded on DEXs, provided there’s enough supply and demand.

Transparency: Every trade and action is recorded on the blockchain, meaning anyone can verify transactions. This creates a high level of trust.

Challenges and Risks of Using a DEX

Like everything, DEXs aren’t perfect. Here are some things to watch out for:

Smart contract risks: DEXs rely on smart contracts, which are only as good as the code they’re written on. If there’s a bug or a flaw, it can be exploited by hackers, potentially leading to significant losses.

Liquidity issues: Smaller DEXs might not have enough liquidity, meaning you could struggle to find a buyer or seller for your trade. This can lead to slippage, where the price you pay is higher than expected.

User experience: DEXs can be tricky for beginners. You need to manage your own crypto wallet, keep your seed phrase safe, understand gas fees, and know how blockchain transactions work. It’s not as simple as logging into an account like a centralized exchange.

Frontrunning: On a DEX, when you submit a trade, others can see it before it’s processed. If someone with faster transaction fees jumps ahead of you, they can snatch up your trade at a better price.

Fees: Depending on the blockchain you are using, fees can be relatively high, particularly when the network is congested.

What’s Next for DEXs?

With advancements in layer-2 scaling solutions (like rollups and sidechains), we’ll likely see faster and cheaper transactions.

Moreover, governance through decentralized autonomous organizations (DAOs) is growing in popularity. Many DEXs are introducing governance tokens that allow users to vote on important decisions. This gives the community more control over the platform’s future.

Another exciting area is cross-chain trading, which allows users to trade assets across different blockchains. While this is still in its early days, it’s a game-changer for making DEXs more versatile and user-friendly.

Closing Thoughts

DEXs are changing the way we think about trading crypto. By cutting out the middleman, giving users control of their assets, and opening up global access to financial services, they offer a compelling alternative to centralized exchanges. 

While there are still challenges to overcome, the future looks bright. As more users adopt decentralized finance, DEXs will likely play a bigger role in how we trade and manage our digital assets.

If you’re interested in decentralized trading, a DEX could be worth exploring. Just remember to do your homework, keep your private keys safe, and be aware of the risks.

Further Reading

A Guide to PancakeSwap

An Introduction to BNB Smart Chain (BSC)

What Is an Automated Market Maker (AMM)?

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What is passive income?

Trading or investing in projects is one way to make money in the blockchain industry. However, that typically requires detailed research and a substantial investment of time – but it still won’t guarantee a reliable source of income. 

Even the best investors can experience prolonged periods of loss, and one of the ways to survive them is to have alternative sources of income.

There are other methods than trading or investing that can help you increase your cryptocurrency holdings. These can pay ongoing income similar to earning interest, but only require some effort to set up and little or no effort to maintain.

This way, you can have several streams of income that, in combination with each other, can add up to a significant amount.

This article will go through some of the ways that you can earn a passive income with crypto.


What are the ways you can earn passive income with crypto?

Mining

Mining essentially means using computing power to secure a network to receive a reward. Although it does not require you to have cryptocurrency holdings, it is the oldest method of earning passive income in the cryptocurrency space.

In the early days of Bitcoin, mining on an everyday Central Processing Unit (CPU) was a viable solution. As the network hash rate increased, most of the miners shifted to using more powerful Graphics Processing Units (GPUs). As the competition increased even more, it has almost exclusively become the playing field of Application-Specific Integrated Circuits (ASICs) - electronics that use mining chips tailor-made for this specific purpose.

The ASIC industry is very competitive and dominated by corporations with significant resources available to deploy on research and development. By the time these chips arrive on the retail market, they are likely already outdated and would take a considerable amount of mining time to break-even.

As such, Bitcoin mining has mostly become a corporate business rather than a viable source of passive income for an average individual.

On the other hand, mining lower hash rate Proof of Work coins can still be a profitable venture for some. On these networks, using GPUs can still be viable. Mining lesser-known coins carries a higher potential reward, but comes with higher risk. The mined coins might become worthless overnight, carry little liquidity, experience a bug, or see themselves hindered by many other factors.

It is worth noting that setting up and maintaining mining equipment requires an initial investment and some technical expertise. 


Staking

Staking is essentially a less resource-intensive alternative to mining. It usually involves keeping funds in a suitable wallet and performing various network functions (such as validating transactions) to receive staking rewards. The stake (meaning the token holding) incentivizes the maintenance of the network’s security through ownership.

Staking networks use Proof of Stake as their consensus algorithm. Other versions of it exist, such as Delegated Proof of Stake or Leased Proof of Stake.

Typically, staking involves setting up a staking wallet and simply holding the coins. In some cases, the process involves adding or delegating funds to a staking pool. Some exchanges will do this for you. All you have to do is keep your tokens on the exchange and all the technical requirements will be taken care of.

Staking can be an excellent way to increase your cryptocurrency holdings with minimal effort. However, some staking projects employ tactics that artificially inflate the projected staking returns rate. It is essential to investigate token economics models as they can effectively mitigate promising staking reward projections. 

Binance Staking supports a wide variety of coins that will earn you staking rewards. Simply deposit the coins on Binance and follow the guide to get started.


Lending

Lending is a completely passive way to earn interest in your cryptocurrency holdings. There are many peer-to-peer (P2P) lending platforms that allow you to lock up your funds for a period of time to later collect interest payments. The interest rate can either be fixed (set by the platform) or set by you based on the current market rate.

Some exchanges with margin trading have this feature implemented natively on their platform.

This method is ideal for long-term holders who want to increase their holdings with little effort required. It is worth noting that locking funds in a smart contract always carries the risk of bugs.

Binance Earn offers a variety of options that let you earn interest in your holdings.

 

Running a Lightning node

The Lightning Network is a second-layer protocol that runs on top of a blockchain, such as Bitcoin. It is an off-chain micropayment network, which means that it can be used for fast transactions that aren’t immediately transferred to the underlying blockchain.

Typical transactions on the Bitcoin network are one-directional, meaning that if Alice sends a bitcoin to Bob, Bob cannot use the same payment channel to send that coin back to Alice. The Lightning Network, however, uses bidirectional channels that require the two participants to agree on the terms of the transaction beforehand.

Lightning nodes provide liquidity and increase the capacity of the Lightning Network by locking up bitcoin into payment channels. They then collect the fees of the payments running through their channels.

Running a Lightning node can be a challenge for a non-technical bitcoin holder, and the rewards heavily depend on the overall adoption of the Lightning Network.


Affiliate programs

Some crypto businesses will reward you for getting more users onto their platform. These include affiliate links, referrals, or some other discount offered to new users that are introduced to the platform by you.

If you have a larger social media following, affiliate programs can be an excellent way to earn some side income. However, to avoid spreading the word on low-quality projects, it is always worth doing some research on the services beforehand.

If you are interested in earning passive income with Binance, join the Binance Affiliate Program and get rewarded when you introduce the world to Binance!


Masternodes

In simple terms, a masternode is similar to a server but is one that runs in a decentralized network and has functionality that other nodes on the network do not.

Token projects tend to give out special privileges only to actors who have a high incentive in maintaining network stability. Masternodes typically require a sizable upfront investment and a considerable amount of technical expertise to set up.

For some masternodes, however, the requirement of token holding can be so high that it effectively makes the stake illiquid. Projects with masternodes also tend to inflate the projected return rates, so it is always essential to Do Your Own Research (DYOR) before investing in one.


Forks and airdrops

Taking advantage of a hard fork is a relatively straightforward tactic for investors. It merely requires holding the forked coins at the date of the hard fork (usually determined by block height). If there are two or more competing chains after the fork, the holder will have a token balance on each one.

Airdrops are similar to forks, in that they only require ownership of a wallet address at the time of the airdrop. Some exchanges will do airdrops for their users. Note that receiving an airdrop will never require the sharing of private keys - a condition that is a telltale sign of a scam.


Blockchain-based content creation platforms

The advent of distributed ledger technologies has enabled many new types of content platforms. These allow content creators to monetize their content in several unique ways and without the inclusion of intrusive ads.

In such a system, content creators maintain ownership of their creations and usually monetize attention in some way. This can require a lot of work initially but can provide a steady source of income once a more substantial backlog of content is ready. 


What are the risks of earning passive income with crypto?

Buying a low-quality asset: Artificially inflated or misleading return rates can lure investors into purchasing an asset that otherwise holds very little value. Some staking networks adopt a multi-token system where the rewards are paid in a second token, which creates constant sell pressure for the reward token.

User error: As the blockchain industry is still in its infancy, setting up and maintaining these sources of income requires technical expertise and an investigative mindset. For some holders, it might be best to wait until these services become more user-friendly, or only use ones that require minimal technical competence.

Lockup periods: Some lending or staking methods require you to lock up your funds for a set amount of time. This makes your holdings effectively illiquid for that time, leaving you vulnerable for any event that may negatively impact the price of your asset. 

Risk of bugs: Locking up your tokens in a staking wallet or a smart contract always carries the risk of bugs. Usually, there are multiple choices available with various degrees of quality. It is imperative to research these choices before committing to one. Open-source software might be a good starting point, as those options are at the very least audited by the community.


Closing thoughts

Ways to generate passive income in the blockchain industry are growing and gaining popularity. Blockchain businesses have also been adopting some of these methods, providing services commonly referred to as generalized mining.

As the products are getting more reliable and secure, they might soon become a valid option for a steady source of income.