Posted 14th August 2023

Beginner’s Guide to Decentralised Exchanges and Lending Platforms

The emergence of blockchains, smart contracts and cryptocurrencies has enabled decentralisation to thrive and introduce the ultimate goal of ushering in an era of decentralised finance (DeFi) to the financial industry. 

One of the primary ways holders of cryptocurrency and blockchain enthusiasts can engage with DeFi is via a DEX (decentralised exchange).

What are decentralised exchanges?

A decentralised exchange (DEX) is a cryptocurrency exchange that does not rely on a central authority to hold user funds or facilitate trades. Instead, DEXs use smart contracts and liquidity pools to automate the trading process and to ensure the security of user funds.

DEXs offer a number of advantages over centralised exchanges, including:

  • Greater decentralisation: DEXs are not subject to the control of any single entity, which makes them more resistant to censorship and fraud.
  • Transparency: All transactions on a DEX are recorded on the blockchain, which makes them transparent and auditable.
  • Efficiency: DEXs do not require the use of intermediaries, which can lead to lower fees and faster transactions.

However, DEXs also have some disadvantages, which include:

  • Complexity: DEXs can be more complex to use than centralised exchanges.
  • Liquidity: DEXs often have lower liquidity than centralised exchanges, which can make it difficult to find buyers or sellers for certain assets.
  • Security: DEXs are still a relatively new technology, and there have been some security breaches in the past.

DEXs offer a number of advantages over centralised exchanges, but they also have some disadvantages. Users should carefully consider the pros and cons before deciding whether to use a DEX.

How do decentralised exchanges work?

Decentralised exchanges such as Uniswap are simple to use and benefit from. Earlier instances suffered from poor user experiences, but in 2023 this is less of a problem. Today, the process is simple:

  1. Users connect their wallets to the DEX.
  2. Users select the assets they want to trade.
  3. Users enter the amount of assets they want to trade.
  4. Users place an order.
  5. If another user is willing to trade at the same price, the trade is executed.
  6. The assets are transferred to the respective wallets.

DEXs are typically built on blockchains such as Ethereum, Solana or Avalanche. The smart contracts on the blockchain automate the trading process and ensure the security of user funds.

What are crypto lending platforms?

A crypto lending platform like AAVE is a financial service that allows users to lend and borrow cryptocurrencies. These platforms are typically decentralised, meaning that they are not subject to government or financial institution control.

Crypto lending platforms work by using smart contracts to automate the lending and borrowing process. Smart contracts are self-executing contracts that are stored on the blockchain. This means that there is no need for a third party to facilitate the lending and borrowing process.

How do crypto lending platforms work?

Crypto lending platforms work in a similar way to decentralised exchanges, and are easy to use if the user has prior experience with cryptocurrencies and interacting with the blockchain. The steps are simple: 

  1. Users create an account and deposit cryptocurrencies.
  2. Users can then choose to lend or borrow cryptocurrencies.
  3. Lenders set the interest rate they are willing to accept.
  4. Borrowers specify the amount of cryptocurrency they want to borrow and the interest rate they are willing to pay.
  5. The platform matches lenders and borrowers.
  6. The cryptocurrency is transferred from the lender to the borrower.
  7. The borrower pays interest to the lender on a regular basis.
  8. The lender can withdraw their cryptocurrency at any time.

Holders of large amounts of cryptocurrency are able to earn significant passive income through this activity.

Types of crypto lending platforms and examples 

There are several different types of lending platforms available now, including centralised exchanges, and we’ll outline some of the most popular ones below:

Peer-to-peer lending platforms

These platforms match humans who want to lend or borrow assets.

DeFi lending platforms

These use smart contracts and algorithms to automate the process using decentralised finance protocols. Lending and borrowing is done entirely using smart contracts, and doesn’t require a middleman or intermediary.

NFT lending platforms

Thanks to advances in blockchain technology, it is now possible for holders of NFTs to lend them out in exchange for a yield. Conversely, those who want to can borrow or “rent” an NFT for a period of time, saving on the cost of purchasing it. 

What are the benefits of lending platforms and decentralised exchanges?

Crypto lending platforms offer a number of benefits to users, including:

  • Access to liquidity: Crypto lending platforms can provide users with access to liquidity even if they do not have a lot of money.
  • Earning potential: Users can earn interest on their cryptocurrency holdings by lending them out on a crypto lending platform.
  • Reduced risk: Crypto lending platforms can help users reduce their risk by diversifying their portfolios.

What are the downsides of lending platforms and decentralised exchanges?

However, there are also some risks associated with using crypto lending platforms, including:

  • Security: Crypto lending platforms are still a relatively new technology, and there have been some security breaches in the past.
  • Liquidity: Crypto lending platforms can experience liquidity issues, which can make it difficult to borrow or lend cryptocurrencies.
  • Volatility: The price of cryptocurrencies is highly volatile, which can make it difficult to earn a consistent return on investment.

Which is the best investment opportunity?

There is a great deal of opportunity for potential investors who have volume ready to lock in DeFi protocols and have a medium to high risk tolerance. Crypto assets experience high volatility and are much riskier than precious metals which have intrinsic value, high demand and limited supply. Risk-averse investors may prefer to consider physical bullion-backed gold and silver-based assets like Kinesis gold and silver.

This publication is for informational purposes only and is not intended to be a solicitation, offering or recommendation of any security, commodity, derivative, investment management service or advisory service and is not digital asset or cryptocurrency trading advice. This publication does not intend to provide investment, tax or legal advice on either a general or specific basis.