Decentralized exchanges are marketplaces that work on a peer-to-peer basis. This means that the traders in the market carry out their activities without any management. Management, in the case, that there is no financial third party or custodian. To carry out transactions, traders use smart contracts. A smart contract is an agreement code that is written to facilitate transactions.
The creation of Decentralized exchanges was based purely on the need for eliminating authorities. This is why most of the transactions are strictly peer-to-peer. This means that the buyers of a particular asset are linked to the sellers. With the market non-custodial, traders are the ones holding the private keys of their wallets. In this article, we will be looking at the top 5 decentralized exchanges on Layer 2.
What is a Decentralized Exchange (DEX)?
Decentralized exchanges are protocols that enable users to use smart contracts to carry out transactions. This is because the activities in the decentralized finance sector are done without the need for a third party. Centralized exchanges are owned by investments looking to make profits and monitor most of their activities. In turn, they are responsible for the safekeeping and regulation of the exchange. Unlike them, decentralized exchanges users are responsible for their safety in the market. This way, they are in charge of their keys and can interact directly with the smart contracts on such exchanges.
How Do Decentralized Exchanges work?
The majority of the decentralized exchanges in the DeFi ecosystem are housed on blockchains that allow smart contracts. This is the same blockchain that traders use to keep their funds safe. To carry out transactions, users pay small fees, which are usually charged with the trading fees. In summary, traders who intend to carry out trades on decentralized exchanges must interact with smart contracts. There are majorly three types of decentralized exchanges: DEX aggregators, Automated market makers, and Order books DEX.
Top 5 decentralized exchanges on Layer 2
Decentralized exchanges built on Layer 2 provide their users with many benefits, including zero or low transaction fees. Asides from that, there is the speed of settlement and massive scalability. These are made possible by taking transactions away from the main blockchain while ensuring the security is still maintained. Layer 2 provides that traders on decentralized exchanges enjoy all the benefits of a centralized exchange while still controlling their funds. Below are the top 5 decentralized exchanges on Layer 2.
Uniswap v3 is an upgrade to the previous version of Uniswap ( v1,v2) that launched in May. The decentralized exchange is based on Ethereum and uses the same Automated market maker as the previous v2 model. Asides from that, it provides a lot of benefits to users and liquidity providers of the protocol. Some of its features include minimized risks, eliminating or minimizing price slippage, and helping traders and liquidity providers increase their profits.
The protocol developers rolled out three main features: concentrated liquidity, oracle feed development, and new fee tiers. Uniswap v3 development was necessary due to users’ complaints about congestion and increased gas fees on the Ethereum blockchain.
The concentration liquidity feature allows traders who provide liquidity to set their price range before depositing liquidity. This means that their rewards will be based on tiers from their risk in a liquidity pool. Asides from that, the gas fees issue vanished after the Uniswap v3 worked on Optimism, a layer 2 scaling solution. Also, swap fees are no longer at 0.3% as on the v2. It now has fee tiers ranging from 0.05% to 0.30% and 1%. This means that the risks increase as a liquidity provider decides the assets they supply to a token pair.
The dYdX protocol is a decentralized exchange that allows the trading of perpetual contracts using low fees. It also provides excellent liquidity and a leverage of up to 25x. To offer its users a great seamless trading experience, it launched on StarkWare, a layer 2 protocol. With the recent surge in the gas fees on Ethereum, dYdX provides users with this scalable solution. StarkWare also has a zero-knowledge roll up which affords traders maximum privacy.
The protocol also allows traders who intend to withdraw their funds to its Layer 1 on Ethereum. Traders holding the DYDX tokens can control a portion of the platform, earn discounts on trading fees, and participate in governing the protocol. DYdX also uses a standard protocol to help governance and the community on the platform.
SushiSwap is a decentralized exchange forking from Uniswap. Not only can traders swap tokens, but they can also carry out other services using the exchange. Just like all other decentralized exchanges, SushiSwap makes use of smart contracts to complete trades. Traders can also provide liquidity so that others can complete trades.
As mentioned above, SushiSwap completes transactions using smart contracts. It is an automated market maker. Users of the exchange lock up funds in liquidity pools which house pairs of tokens used to complete trades. Also, staking and lending services happen on the platform. Using the Polygon network, Sushiswap provides users with low fees on trades and fast processing instead of the congestion on Ethereum.
Quickswap is a DEX forking from Uniswap. It was developed in October 2020 on the Polygon network, which is a Layer 2. With its deployment on Polygon, users of QuickSwap enjoy lower transaction fees and fast transactions compared to Ethereum. Holders of the QUICK token, the native token of the protocol, have exclusive rights over changes made in the protocol.
The protocol started to solve the issues plaguing Ethereum at the period. These issues, including fast transactions and low fees, were enough to push users out of the DeFi sector. With its development on Polygon, QuickSwap completes about 65,000 transactions every second. QuickSwap also has features like Dragon Lair, which allows users to earn rewards from staking the native QUICK tokens of the network.
Curve is an automated market marker DEX that initiated on Layer 2, Polygon. It allows users to exchange tokens and wrapped assets with very low fees. Asides from providing liquidity and earning rewards in turn, users can earn rewards through yield farming on Aave. The main reason Curve moved to Polygon was due to the massive congestion and high fees on Ethereum.
The major reason why traders will want to consider these decentralized exchanges is because of their scaling solutions. With Etheruem based exchanges suffering great congestion and high transaction fees, these layer 2 exchanges eliminate those. However, traders should note that they should research a lot in order to pick out the best. This is because things change, and decentralized exchanges provide new features on their protocols every day.
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