Something that’s so liberating about Decentralized Finance is that we can exchange Cryptocurrency in a completely Decentralized way. No need for exchanges, no need for custody, no need to trust. But despite the DeFi space being a relatively new phenomenon, there are already several alternatives when it comes to Decentralized exchanges. Each of them has its own unique pros and cons.
What is Decentralized Exchange ?
A Decentralized exchange is a platform where you can exchange two different Cryptocurrencies without the need for a centralized entity, they are non-custodial and trustless, non-custodial because unlike Coinbase or Binance, your funds are never kept on them trustless because unlike shape, shift or change, you don’t need to trust that they will honor an exchange.
Essentially, when you make an exchange on a Decentralized exchange, you’re doing so with another trader in a peer-to-peer fashion. If these are Ethereum based ERC 20 assets, as is the case with 90 percent of DeFi, then these are done on chain. This means that you’re transferring the asset in a transparent way on the Ethereum Blockchain these Dex’s are also built as Decentralized applications or Dapps. This means that in order to interact with them, you will have to use a Web 3.0 wallet on your browser.
These include the likes of Metamask, Trust wallet, Coinbase, wallet, etc.. These wallets will then be used in order to sign transactions and authorize the dapps. My personal preference for all of this is metamask, which is compatible on most modern web browsers. I also use my metamorphic in conjunction with a hardware wallet like a ledger. This means that my keys are left secure in cold storage on my hardware wallet. However, if I need to sign transactions through it, it’s just a matter of connecting it to metamask and making sure to authorize the transactions.
What are the benefits of using a dex? Well, the first and most important is that you always remain in control of your keys. You and you alone can determine exactly what you want to do with your Crypto.
When you use a centralized exchange, you have to trust that not only is there security up to scratch, but also that they will honor all of your withdrawal requests. Another great benefit of these Decentralized exchanges is that they’re anonymous. You don’t have to submit any KYC docs. This is great for those privacy hawks that would prefer not to entrust their documents with those aforementioned centralized exchanges.
Heck, even if you use a non custodial exchange option like a changelly or shape shift, they often do require KYC documents in order to complete a transaction.
This is not really the fault of an exchange. They’re required by law to know that customer and fight money laundering.
However, with a Decentralized exchange, there’s no one controlling it, and the regulators can’t really turn to anyone to request this enforcement.
One more benefit of these Decentralized exchanges is the opportunity to earn income yourself. You can do this by providing liquidity to their trading pools and thereby helping in the exchange of Cryptocurrency. You’re rewarded not only in the form of trading fees, but you can also earn liquidity pool tokens which are paid out to those who are supplying the liquidity. All the benefits mean that these Dex’s have become insanely popular. For example, in July, Dex’s made up almost four percent of Decentralized exchange volume more recently.
Twenty four hour Eth trading volume on Dex’s broke half a billion dollars.
Take a look at this graph. This is the total trading volume on Dex’s since January of this year. It’s pretty damn mind blowing, if you ask me. So that’s it for our overview of Dex’s, it’s time to jump into the top decks on the market currently, and that is Uniswap. Uniswap launched back in late twenty eighteen before DeFi was even a thing. It started without any sort of fanfare, public sale or governance tokens. Heck, even to this day, Uniswap does not have its own token.
What is Uniswap ?
So what is uniswap? Well, it’s a Decentralized exchange that has done away (means dont have) with the concept of orderbook entirely. It is what is termed an automated market maker. When you want to trade on Uniswap, you enter the amount that you would like to trade and uniswap will provide a rate.
This exchange is facilitated through the use of global liquidity pools for ERC 20 assets. With these pools that uniswap is able to create a unique market for any two assets. Sounds pretty simple, but the way that Uniswap is able to do this is pretty ingenious. It uses what is termed the constant product market maker model. Basically Uniswap is able to provide liquidity by adjusting the price of the order up based on the size relative to the pool of liquidity.
Of course, this will lead to significant price slippage on the order if there are smaller pools.
However, this has the benefit in that it ensures that the pool never runs out of liquidity. The user also has the ability to specify A maximum slippage amount that you’re willing to accept.
Don’t let the complicated order proceed for you that uniswap is amazingly easy to use.
The user interface has to be one of the most simple and uncluttered.
This is the UI of Uniswap version two, which was launched a few months ago. As you can see, we need to connect your Web 3.0 wallet and you’re ready to switch your tokens. As you can see over here, there are two options. You can either do the swap or you can pull. Let’s start on the swap function. This is the feature that you will use when you want to exchange two ERC 20 assets, put the amount that you’d like to trade over here.
Below the trade you’ll have all of the order parameters. You’ll see the potential price impact of the trade, the liquidity provider fee, as well as the route the order will take, if any. Oh, and by the way, up in the top right here, you have the option to further customize your order. You can set the maximum slippage amount they are willing to accept, as well as the time that you’re willing to wait for the transaction to execute.
I should also point out that you have the option to forward on the transaction to an external address as well. This can be done with this ad ascend feature over here. When that is all said, you can improve the spend and transaction on your metamask. This will then do the swap according to the parameters that you’ve set. OK, so that’s how the swap feature works. Let’s talk about that pool option.
In Uniswap, you can also provide liquidity to the pools that other traders can use in order to facilitate the transactions, the smart contracts will then use the pooled assets to swap the tokens traders are looking to convert.
As a liquidity provider at Uniswap, you’ll get a share of those liquidity provider fees that they charge all of their traders. This is a pretty neat way to earn additional returns on your Crypto holdings if there’s a lot of trading activity. However, there is something very important that I need to illustrate here.
Basically, if you were supplying liquidity to a pool on Uniswap, then you run the risk of impermanent loss. This is basically a term that’s used to describe the opportunity cost you could incur due to a relative change in the composition of your pooled funds.
When you supply funds to Uniswap, you have to do so that you have the exact dollar equivalent of either asset. So let’s say you’ve supplied one hundred dollars in Ether for one hundred dollars in BAT, so that they each make up 50 percent of your share of the pool. However, as trading takes place in the pools, this composition may shift either way towards one or the other. This means that your relative weighting may change and hence you’re not in control of your allocation.
We’ll come back to this impermanent loss issue in the next dex. Then, assuming that you’re ready to start supplying liquidity, you will hit pool and add liquidity here. You’ll then select the tokens you would like to pool for. You can either supply to a pool that already exists or even start your own pool if you want. By importing the token in order to pool, you’ll have to provide them in the same dollar value. Proportion it all good.
Then you’ll have to first unlock your tokens and then approve to the pool and your Poolan. Do keep an eye on your proportions in the pool, as you do not want to fall victim to that impermanent loss if you can help it. There are a few other features and functions that you may want to know about with Uniswap.
What is Curve Finance
Time to move on to my next Dex. Curve Finance is another dex, like Uniswap, this is a Decentralized exchange that makes use of liquidity pools. However, it facilitates high liquidity with minimal slippage for stable coins.
This is all possible through the use of what are termed bonding curves. The exact mechanics of it are beyond the scope of this video, but it’s basically a method to minimize price slippage. You can see in the below diagram that the price impact from swaps on curve is less pronounced than it is on Uniswap. Now, something that you may find quite interesting about Curve is this user interface. It’s much more complicated and nowhere near as clean as that of Uniswap.
But I do personally like it a lot. It harks back to the early web days when I was first playing around on the Internet. Despite this interface, it’s pretty damn simple to do a trade on the home page, you have all of the tokens that you can swap between. As you can see, it consists of stable coins and pegged Bitcoin, as you can see below the swap function. I have more functionality around the order that I can adjust.
This is through the advanced tab down here below. Similar to the case with Uniswap, you can set the max slippage, restrict a particular order routes and customize your fees, you then hit cell and the decks will ask you to confirm that on your Web 3.0 wallet.
Although you do have the function to set your max slippage on these orders, you will have much less of an impact because of their unique bonding mechanism. So this is all well and good. But perhaps one of the coolest things about Curve Finance is what you can do on the other side of the trade. You can supply some liquidity and farm some yield. Yeah, for those of you who’ve watched my previous video on YouTube, you will know that I have already been tending some crops in the DeFi fields.
I’ve been supplying liquidity to curve pools in order to generate token rewards. These are token rewards that are on top of the fees that one earns from just providing the liquidity. I’ll get to all that. Let’s start with the basics. Much like at Uniswap, when you supply liquidity to a pool, you’re providing users with an opportunity to swap their tokens one for another. However, an interesting thing to note about doing so is that you don’t have too much risk from impermanent loss.
This really comes down to the types of assets that you’re providing liquidity for, given that the equivalent in price all the time, there’s no difference in your portfolio holding if you have more of the one than the other. For example, if you hold 80 percent USDC and 20 percent PAX, your portfolio value will be the same. If you had 20 percent USDC and 80 percent PAX, the two are equal to each other. Make sense so far. OK, so you can supply liquidity for traders on Curve.
But there have been a number of unique incentives that are provided by project teams in order to increase intermarket liquidity for their tokens. Compound Finance started this craze with their COMP governance tokens. Since then, we have had a lot of liquidity mining tokens that have been released on the market. In fact, if you head on over to the Curve Finance homepage, then you’ll see all of the liquidity pools at the moment, which you can join, as you can see on top of the generalized % APY you can expect from supplying liquidity.
You can also earn these additional rewards, YFI, Ren, SNX and Balancer token, I’m actually supplying liquidity to this pool over here of Synthetix Bitcoin. I want to keep exposed to Bitcoin as well as earning some returns on it. Not only am I receiving SNC and Ren from the Balancer pool tokens, but I’m also earning Balancer rewards. You can supply any of the other pools there, including the US dollar, stable,coin pools if you would like to hold the dollar value of your investments.
So if you want to supply liquidity to one of these pools, you can do so with the deposit button right over here. This will take you to this screen here. When supplying the coins, you can do so in a proportion of your choosing, however, because you are at risk of impermanent loss. I would just supply them in equal proportion. Then once you were okay with the parameters in terms of gas and contract approvals, you can hit deposit and stake.
This will unlock a Crypto from your wallet and stake it on the Curve contract. There is one more thing that you want to consider here, and that is that curve also has just released their own governance token CRV. This CRV rewards are distributed to all of those that are supplying liquidity to curve pools.
It’s also given to those people who have been providing liquidity prior to the launch. I’ve been providing liquidity to the pools since June, so I’ve accumulated some CRV myself. Of course, most of these are vested and will be released slowly over the next year. So, yes, that’s just a quick overview of providing liquidity on Curve Finance.
What is Balancer
Balancer. Balancer is a pretty ingenious dexs and Crypto asset management platform, it acts as an automated portfolio manager, liquidity provider and price sensor. So it’s really a bit of a Swiss Army knife dex, one of the main benefits of Balancer is the way that they approach that problem of impermanent loss, whereas it uniswap you run the risk and it curve. You’re supplying stable coins at Balancer. You can supply liquidity of any Crypto asset in any proportions and get those rewards.
Users can deposit any asset that they desire and still earn liquidity fees on it. They can also adjust their allocations to suit their own individual needs. This makes Balancer a great solution for DeFi users who want to earn passive income on Ethereum based assets while retaining exposure to the underlying asset, the mechanics of how this work is pretty involved.
Head on over to Balancer dot exchange and connect your wallet, once that’s done, you will hit add liquidity. This will pull up the pool management dashboard. Now, there are plenty of public pools that you can join now over twelve hundred and counting. This means they will most likely be a pool that is well shaped according to your desired allocation. If you want to narrow it down, you can filter if your desired asset. Over here I want to hold Ether.
So I put in wrapped Eth. Oh, for those of you who don’t know what w eth is, it’s just a wrapped Eth a token that was minted according to the ERC 20 standard. Anyways, I can scroll through all of these pools and decide which one I would like to supply liquidity for. Balancer supports pools of up to eight different tokens, so it gives you a hell of a lot of scope for different allocations. I suggest examining the pool for key aspects like balance, volume and fees.
If you wanted to, you could also start your own pool if the allocation that you want is not available. A pretty neat feature if you hold an exotic ERC 20 portfolio in weird allocations. Once you found the pool that you’d like to supply liquidity to, you just hit add liquidity over here, you’ll need to set up your own proxy contract in order to manage liquidity on balancer in the long term. You only need to do it once, though, so don’t worry about those exorbitant gas fees.
Once that set up, you can enter the desired amount under the deposit amount field and unlock the listed assets so Balancer is able to access them.
Lastly, submit the final transaction by clicking add liquidity. Once in a pool, users can remove liquidity at any time by clicking the remove liquidity button. So that is how you supply liquidity to Balancer pools. You’ll notice how the pool will keep that allocation and you will have full exposure to the underlying asset while earning those returns. Oh, and there’s one more thing that I want to add. Balancer has its own governance tokens that they’ve also been distributing as a reward for providing liquidity.
This is released on a weekly basis of one hundred and forty five thousand Bal tokens. These are government tokens like the curve rewards or compounds and are sometimes difficult to value. However, if the performance of government tokens over the past two months is anything to go by, they can be pretty damn valuable. I encourage you to read more about the distribution in the blog post that I’ve linked to below.
Now, although these smart liquidity pools are a primary feature of the Balancer protocol. There’s also a pretty effective dex function on the Balancer exchange. Head on over to Balancer dot exchange and you’ll see the following interface clean, uncluttered and simple, you’ll just have to select the asset that you’d like to swap and the resulting token you would like to receive. Once that’s done, you’ll see the following interface with the exchange rate and the expected price slippage. As with the other Dex’s above, you can define the maximum price slippage that you’re comfortable with.
Something else is pretty neat is that you can click this dropdown here and it will show you exactly how the order has been optimized using those Balancer pools. Basically, Balancer uses smart order routines in order to find the cheapest exchange options between these different pools.
Once you’re comfortable with your order parameters, then you can hit swap, confirm the action on your Web 3.0 wallet and the swap will process and exchange the tokens.
I encourage you to read up on them and understand their quirks and features before putting a lot of Crypto into any. I also think it’s really important to point out that despite their popularity, there are still challenges and risks. For one, gas fee are making a lot of these DeFi protocols incredibly expensive to use.
This means that it excludes a lot of the people who prefer to start with smaller amounts of Crypto not ideal when Eth 2.0 ? then, of course, you have your risks when you dabble in the DeFi waters, you are taking full responsibility for it. Hack’s do happen. Smart contracts do have box pools do get drained and manipulated. These are all tail risks that you should be aware of if you’re going to be supplying liquidity.
The main precaution you can take is limiting your risk to any one singular pool.