By now, you may have heard the term "Decentralized Exchange".... but what does it really mean? And how is a decentralized exchange (DEX) different from a centralized exchange (CEX) like Binance or Coinbase?
The major difference of these two types of exchange platforms is custody. Unlike CEXes, no central authority or third party is involved in the operation of a DEX. As a result, a user retains full control of their funds stored or traded on DEXes, which offer a higher degree of security than CEXes. While CEXes are believed to be faster and historically offer better user experience than DEXes, the latter have recently shown massive improvements in those areas.
Another major difference between these two, is the way that trades are facilitated. On a CEX (like Binance) off chain order books are used to match buyers with sellers. This is based off of the traditional order book model, which traditional finance (trad-fi) exchanges have used for centuries. However, on a DEX an entirely different system of execution is used. This is called an Automated Market Maker (AMM) model.
Simply put, an AMM model consists of a liquidity pool that holds two tokens (a pair) which is governed by an algorithm in charge of maintaining a specific balance of the pool. When a buyer places a trade, the algorithm will appropriately provide a price (based on the ratio of tokens), and execute the trade on behalf of the buyer. Then when a seller comes along, it will do the same thing, adjusting the price with the goal of restoring balance to the pool. While this method may seem complicated at first, it is a revolutionary means of facilitating trades in any on-chain market. The AMM model removes any third party, and allows traders to maintain custody of their own funds.