Bitget Wallet Practical Guide to DeFi EP1: Decentralized Exchange

DeFi, a term you have been hearing and seeing everywhere in the Web3 and crypto world. But the real question is, however, have you been using it?

Many crypto users are still stuck in the 2018 crypto era when people bought ICO (Initial Coin Offering) tokens from exchanges. But things have changed drastically since then. Fast forward to 2022, and an average person with decent crypto knowledge can easily launch their token and smart contract on a chain with less than 20 learning hours. The development in the crypto world is happening so quickly that there can be no actual progress without any real hands-on experience. That's why Bitget Wallet (Previously BitKeep) is bringing you a simple guidance manual for newcomers and centralized service users to start DeFi as quickly as possible.

Decentralized finance, aka DeFi, has taken off in the last three years, especially after the pandemic hit and governments started handing out stimulus money to citizens. The middle class, who had a lesser financial burden, began looking for ways to make their extra money work for them, and DeFi provided the solution. More and more people have realized that DeFi is the next big thing, and it's successfully attracted even more money into the ecosystem.

At the beginning of 2020, the year the pandemic started and the start of the bull run in all financial markets, DeFi's Total Value Locked (TVL) was at a modest $600 million. Here's the first bit of jargon you need to know in DeFi: TVL stands for “Total Value Locked,” which refers to the number of user funds deposited in DeFi protocols. These funds could be vested in the project for several functions, such as liquidity pools, staking, or lending. Think of it like the money you deposit in a bank in the real world, except in DeFi, we are our own bank and get to decide what to do with our deposits rather than leaving that decision up to the bank.

Back to story time, by June 2020, DeFi's TVL broke the $1 billion mark and continued its upward trajectory, reaching a peak of $15 billion in October 2020. This was just the beginning, as the DeFi summer lasted over a year. On-chain statistics show that DeFi's TVL grew more than tenfold from $15 billion to over $170 billion by December 2021, the last bull month of the long run of DeFi summer.

In the first chapter of Bitget Wallet (Previously BitKeep)'s Guide to DeFi series, we're diving into the easiest level of DeFi: the decentralized exchanges (DEXes). Most crypto users start their Web3 journey with centralized exchanges, but despite the massive success of DeFi in recent years, many crypto users have heard of it but have yet to utilize it. That's why DEXes are the perfect entry point.

There are countless DEXes out there to choose from, and Uniswap is the largest among them. While Uniswap may not have been the first DEX ever created, it is undoubtedly the pioneer of the liquidity pool (LP) mechanism. A DeFi protocol with the same name was built in 2018, and it's safe to say that Uniswap is the mother of all DEXes. Aside from the typical DEX, there are new protocols that aggregate all the DEXes and choose the best option for users when they are trying to make a swap. Bitget Wallet (Previously BitKeep) Swap is one of the reputable DEX aggregators in the crypto industry, which helps to optimize your transactions with liquidity aggregated from multiple DEXes and cross-chain bridges. Let's swap some tokens and learn about how swapping works.

Expected Output: This is the estimated total amount of tokens you'll receive after the swap.

Slippage: This refers to the percentage difference you're willing to accept while executing a swap. The default rate is usually 0.5%. If you're swapping coins during an enormous price movement, say if the ETH price suddenly drops 2% during the swap, your transaction will likely fail as the slippage is only 0.5%. In this case, you can manually increase the slippage to 3% and even more via the options button. However, high slippage is only required when trading for very low-cap altcoins. Only adjust slippage if you know what you're doing.

Price Impact: This is the percentage of price impact on the market. A significant price impact will occur if you swap too many tokens at once or trade for low-liquidity altcoins. Be cautious if the price impact is high, as you may lose money by receiving less than expected token output. The lower the impact, the better.

TX Fee: This is the transaction fee paid to the protocol as a swap service fee. Gas fees are excluded. Pro-tip for on-chain swapping: swapping on Ethereum is costly due to its relatively high gas fee. Therefore, swapping on a Layer 2 chain, such as Arbitrum and Optimism, is better if you are taking part in DeFi in the long run.

In a typical centralized exchange (CEX), the order book is a crucial feature. It's an electronic list that shows buy and sell orders for a particular asset, organized by price. For instance, in the case of bitcoin, the order book displays the number of bitcoins being bid or asked at each price point or market depth. To make the order book work efficiently, the CEX server must be lightning-fast and handle millions of transactions within milliseconds. A blockchain transaction, on the other hand, may take up to 10 seconds to execute. It is too slow compared to the CEX server, which can execute an order within milliseconds.

Besides the order book, there's another essential player in the game – the market makers. Market makers provide liquidity by placing orders on both sides of the trade. Decentralized exchanges don't have traditional market makers; instead, they use Automated Market Makers (AMM). AMM facilitates the exchange of tokens using liquidity pools instead of conventional market order books. You can think of swapping using DEX equals placing a market order in a CEX – it's an order to trade at the market's current best available price. AMM is one of the defining features of DeFi. While some new DeFi protocols implement the order book feature, AMM-based DEXes are still the most popular in the DeFi world due to their deeper liquidity pools.

Overall, DEX is easy and convenient; there's no need to create an account, upload personal credentials, or worry about KYC or region locks. We often hear about CEXes halting withdrawals or trades of certain coins to "protect" their users. Even some of the largest centralized exchanges face such issues. DEXes are free from this obstacle and run 24/7 without any downtime. With just a crypto wallet on your browser or mobile phone, you can access different DEXes within a few clicks. To trade on a CEX, we must first transfer our crypto assets into an account we create with identity proof and KYC. If anything happens to the exchange, our assets are at risk. However, that doesn't mean CEXes are a terrible choice. They offer low fees and sometimes zero fees for spot trading. Users’ assets are safer from hackers in the custodian of a CEX as it is difficult to hack and withdraw funds deposited in a CEX due to authentication, such as Google's authenticator, Apple's Touch ID, or 2FA. However, as we delve deeper into the blockchain world, we begin to realize the constraints of CEXes and start using DEX more frequently. And that's where we begin our journey to explore the world of DeFi.