For most crypto enthusiasts, peer-to-peer (P2P) trades on blockchain networks, free of centralized exchanges (CEXs) or third-party intermediaries, are more than a priority – they’re a core principle of decentralized finance (DeFi). 

The same often goes for self-custody, where investors maintain complete control and ownership of their digital assets without outside interference.

But blockchain-based decentralized exchanges (DEXs) also offer traders even more, such as opportunities to earn passive income through features like liquidity pools, where users contribute tokens to support trading activity in exchange for potential rewards.

In this guide, we’ll explain how crypto DEX platforms work, their advantages and drawbacks, and how they’re transforming the way investors trade digital assets.

What is a DEX in crypto?

DEXs are P2P marketplaces where users trade crypto directly with each other instead of relying on intermediaries such as banks or payment processors. Rather than using centrally controlled order books or cloud servers, DEXs operate as decentralized applications (dApps) built on blockchain ecosystems like Ethereum (ETH) or Solana (SOL). To trade on a DEX, users connect a compatible self-custodial wallet, such as MetaMask, to the dApp and swap digital assets within the protocol.

Thanks to blockchain technology, all transactions on a DEX are recorded on the underlying chain’s immutable distributed ledger, providing a secure, trustless, and counterparty-free trading experience.

Centralized vs. decentralized exchanges

The main difference between centralized exchanges (CEXs) and decentralized exchanges (DEXs) lies in who controls the protocol.

On a CEX, a single company manages transactions through an order book and secures all assets stored on the platform. While traders can transfer tokens from a CEX to a self-custodial wallet, their cryptocurrencies remain vulnerable to counterparty risks as long as they’re held in the CEX account. CEX users also must often provide personal details – such as their name, address, and phone number – to meet know-your-customer (KYC) requirements.

Conversely, DEXs operate without a central authority. Trades are facilitated by the dApp’s protocol, allowing users to transact directly between their crypto wallets. This decentralized structure removes counterparty risks and gives traders complete control over their assets. DEXs also prioritize privacy, as they don’t require KYC information from users.

How does a DEX trading platform work?

Several approaches to creating DEXs exist, but one of the most common is the "automated market maker" (AMM) model. AMM DEXs rely on smart contract-governed protocols called "liquidity pools," where investors, known as liquidity providers, deposit asset pairs to support trading activity. By locking their cryptocurrencies into these pools, liquidity providers earn a share of transaction fees proportional to their contributions.

Once the liquidity pools are funded, traders connect their wallets to the DEX and swap cryptocurrency pairs using the assets in the pool. Meanwhile, the AMM’s smart contracts and algorithms continuously balance the pools and facilitate swaps, all without the need for intermediaries.

While AMM DEXs are currently the most common type of DEX in web3, there are other models, too, such as onchain or offchain order book DEXs. Order book DEXs either record transactions directly on the blockchain or use a centralized offchain server to enhance transaction speed and lower fees. Although less prevalent than AMMs, order book DEXs provide an alternative approach to crypto swaps and are utilized by platforms like Injective (INJ) and dYdX (DYDX).

Benefits and risks of DEXs

Many crypto investors consider DEXs the ultimate solution for token trading– they prioritize online privacy and minimize counterparty risks. That said, they’re not without their disadvantages. Here’s a closer look at some of the main pros and cons of DEXs.

Pros of DEXs

• Control over digital assets: DEX traders never have to relinquish ownership of their digital assets. All of the swaps on a DEX take place using self-custodial crypto wallets, so traders always have complete control over their digital assets. 
• Trustless trading: By using liquidity pools and smart contracts instead of intermediaries, DEXs eliminate counterparty-related risks like data manipulation or mismanagement. Many DEXs also publish audit reports to demonstrate the security of their code, enhancing user confidence.
• Access to a wider range of projects: DEXs are often the go-to for discovering new and innovative crypto projects, such as altcoins. Developers also frequently launch initial coin offerings (ICOs) on DEXs, giving investors early access to cutting-edge protocols before they’re listed on centralized exchanges. 
• Increased online privacy: DEXs don’t require investors to provide KYC in order to trade. A compatible crypto wallet is all you need, allowing for a more private trading experience.

Cons of DEXs 

• Limited screening of listed assets: Although new token listings on DEXs may turn out to be successful protocols, there's a greater risk for scam tokens and pump-and-dump schemes. DEXs typically don't have the same vetting processes as CEXs, meaning it's important to "do your own research" (DYOR) and watch out for warning signs of fraudulent coins.
• Complex user interface: If you're new to crypto and using wallets,  you might have a tougher time familiarizing yourself with the UI/UX on DEXs. Even though developers are working on improving their dApps, swapping tokens and confirming transactions can come with a steeper learning curve.
• Limited customer support and no insurance: Unlike CEXs, DEXs don’t offer insurance protections, and their customer support is limited. While they can't recover lost funds or reverse failed transactions, they may assist with wallet connection issues, bug reports, and other technical concerns.
• Vulnerable to hacks and smart contract exploits: The smart contracts underpinning DEXs can be susceptible to bugs, exploits, or coding vulnerabilities. If a DEX’s smart contracts are flawed, users could lose funds.

What are the top DEXs in cryptocurrency?

Daily trading volumes on DEXs are constantly shifting, with dozens of new protocols entering the web3 space every year. To stay up-to-date on high-performing DEXs, new crypto traders often rely on third-party aggregator sites like CoinMarketCap, CoinGecko, or DeFiLlama. The "DEXs" tab on these platforms provides details such as current trading volumes, user visits, and the most popular trading pairs.

While these DEX screeners are valuable tools, a few platforms consistently dominate a significant portion of web3's traffic.

Uniswap

Launched in 2018 by developer Hayden Adams, Uniswap (UNI) is one of the original DEXs in the Ethereum ecosystem and a pioneer of the AMM model. Its core algorithm, the "Constant Product Formula" (x * y = k), maintains 50/50 liquidity pools as users trade cryptocurrencies. Uniswap currently only supports ERC-20 token trading, though it has expanded access to multiple Ethereum Virtual Machine (EVM)-compatible networks, including Arbitrum (ARB), Optimism (OP), Polygon (MATIC, Avalanche, Base, BNB Chain, and more. For added convenience, Uniswap offers a self-custodial wallet available on iOS and Android and as a Chrome browser extension, allowing users to connect seamlessly to its exchange.

Raydium

Like Uniswap, Raydium (RAY) is an AMM-based DEX that allows traders to swap crypto directly from their wallets. However, Raydium exists on the Solana blockchain, which differentiates it from Ethereum-based DEXs. Since its 2021 launch, Raydium has become one of Solana's most popular DEXs, offering features like yield farming, staking its native RAY token, and liquidity pools.

PancakeSwap

Another popular AMM DEX, PancakeSwap (CAKE) is specific to the Binance Smart Chain (BSC). Released in 2020, it quickly gained major attention for its low-cost trading experience compared with Ethereum-based competitors with higher gas fees. PancakeSwap also stands out for its yield farming, staking, and lottery opportunities, which allow crypto traders to earn the platform's CAKE governance token.

Curve Finance 

Like Uniswap, Curve Finance (CRV) is an AMM DEX in the Ethereum ecosystem, but it uses a different balancing algorithm optimized for low-volatility cryptocurrency pairs. Typically, crypto traders who use Curve are most interested in swapping like-kind cryptocurrencies, such as two stablecoins pegged to the USD – like Tether (USDT) or USDC (USDC) – or synthetic pairs with a low risk for divergences in the quoted and final price (slippage). Thanks to its focus on low-volatility pairs, Curve Finance is popular with liquidity providers who want more reliable token rewards without worrying about volatile price swings.

Optimize crypto purchases and tracking with CoinTracker 

Whether DEXs are a central part of your crypto trading strategy, you're earning passive income through liquidity pools, or you're engaged in other DeFi activity, CoinTracker helps keep you compliant. With seamless integration to crypto wallets and smart contracts, CoinTracker's Portfolio Tracker records your transactions and organizes them into tax-compliant forms in minutes.

Get started for free today, and join the millions of DeFi users who trust CoinTracker with their crypto tax reports. 

Disclaimer: This post is informational only and is not intended as tax advice. For tax advice, please consult a tax professional.