According to CoinMarketCap, more than 20,000 cryptocurrencies are offered. This is a function of blockchain’s core function – the monetization of decentralization through digital assets. Because of this, even tiny protocols (dApps) have their own tokens on a larger blockchain network.
The swap rate is an exchange of equal value between two cryptocurrencies. For example, let’s say we have $1,000 worth of Avalanche tokens and $1,000 worth of Ether.
swap value
The new denomination of 0.64 ETH still represents a value of $1,000. This means that we swapped AVAX for ETH at the market exchange rate, which is from one centralized exchange (CEX) to another and from a decentralized exchange (DEX) to others may vary.
So, the swap rate refers to exchanging cryptocurrencies directly without first exchanging them for dollars and then for the other cryptocurrency. In theory, the token swap price should return $1,000. Nonetheless, there is friction to enable the swap that reduces the final swap value.
What is a market exchange rate?
The value of a cryptocurrency rises and falls with demand. When more people are willing to buy a cryptocurrency than there is on offer, the value of any coin, like BTC or ETH, increases. This is the battle between supply and demand. Cryptocurrencies with higher inflation rates will have a higher inflow of new coins, meaning their demand must be higher to maintain value.
Case in point: After The Merge, Ether issuance rate was drastically reduced, even going below Bitcoin.
Source: Ultrasound.Money
This is despite the fact that BTC has a forever limited supply of 21 million coins, while ETH supply is unlimited. Market exchange rates that follow the ups and downs of supply and demand are the most common, referred to as floating rates.
In contrast, market exchange rates that are fixed at a value are referred to as pegged. Typically, these are one nation’s currencies pegged to another nation’s currency such as the US dollar.
Cross-Border Payments
In traditional banking, it can take one to three days for businesses to process cross-border payments and seconds for consumers. The cross-border payment system is still largely dependent on intermediaries, which can create friction and additional costs.
Blockchain networks have their own friction in the form of decentralized fees. For example, Ethereum validators and Bitcoin miners receive fees paid by senders when they process transactions as a new block on the blockchain’s public ledger.
Centralized crypto platforms like Binance or Coinbase work in a similar way to TradFi institutions. They compete with other CEXs who set their swap rates. On DEXs, swap rates are formed organically because they depend on users themselves supplying tokens into liquidity pools.
Additionally, token holders on DEXs, such as B. UNI tokens for Uniswap, use these governance tokens to optimize swap rate fees.
Swap on Centralized Exchanges (CEXs)
Just like exchanges, CEXs facilitate the exchange of assets. Because they rely on a clear ownership structure to generate profits, CEXs operate as a corporation. This means that they have to be registered as such with the relevant authorities.
These agencies, in turn, set the rules by which CEXs operate. At the bottom of this centralized chain, CEXs impose conditions on users for them to exchange tokens:
- identity verification
- Biometric Verification
- Proof of name and address
- Payment ID Proof
These know-your-customer (KYC) checks are the result of decades of attempts to curb money laundering by criminals and terrorists. CEXs conduct KYC and Anti-Money Laundering (AML) assessments to ensure customers are engaging in legitimate financial practices. You must do so or face penalties from regulators.
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CEXs contain users’ private keys, which is a key point of failure. If the exchange gets hacked, there is a risk that all these digital assets will be stolen. As a side benefit of the digital assets not being held directly, users are not directly exchanging cryptos on CEXs. Here’s how this process works:
When a swap order (trade) is placed, the CEX takes control of the deposited swap funds.
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In return, the CEX issues promissory notes of the appropriate value, which can only be exchanged upon payment.
In the blockchain world, promissory notes are smart contracts that record cash inflows and expected outflows – the swap rate.
The CEX then uses an order book to match asks with bids, such as B. xx AVAX for xx ETH, and covers the spread with its own liquidity. After matching, the CEX executes the swap at the current market exchange rate.
Swap on Decentralized Exchanges (DEXs)
Unlike CEXs, DEXs reinforce user privacy and autonomy. There is no company or CEO managing a DEX as the users themselves provide the liquidity needed to run token swaps.
Additionally, users with non-custodial wallets connect to DEXs, eliminating the need to comply with KYC requirements. How they work:
- A user connects to a non-custodial wallet like MetaMask using a DEX protocol.
- A user can then either provide liquidity or exchange tokens from existing token pair pools.
- Token pairs like BTC/USDC are smart contracts that pool deposits from people who have decided to provide liquidity. So they are Liquidity Providers (LPs).
- When people who only trade tokens resort to liquidity pools, they give a small share of LPs. This is the friction exerted by the DEX, on top of paying the network’s gas fee.
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To match token swap requests and bids, DEXs use automated market makers (AMMs). However, since there is no central body providing liquidity, this means that a DEX is entirely dependent on its popularity. If it is less well known, there will be fewer LPs to provide the necessary liquidity, which will stall token swaps.
Although DEXs can register any token without permission, the ability for that token to be exchanged depends on the popularity of the DEX.
Do Swap Rates Matter on CEXs vs DEXs?
Not really. Although CEXs charge higher transfer fees and withdrawal fees and have a costly corporate structure, they offer swap rates within reach of DEXs. This is because the crypto space is run by arbitrage bots.
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These computer programs hunt swap rate differences between different platforms to maximize profits. For example, if arbitrage bots find an ADA/ETH pool with low liquidity, traders could benefit by buying the requested tokens from CEXs. Then they would deposit/sell them into the pool for a profit.
As this process repeats itself over and over, both DEXs and CEXs balance their swap rates.
Disclaimer for the series:
This series article is for general guidance and information only for beginners participating in cryptocurrencies and DeFi. Nothing in this article should be construed as legal, business, investment or tax advice. Consult your advisors for all legal, business, investment and tax implications and advice. The Defiant is not liable for lost funds. Please use your best judgment and exercise due diligence before interacting with Smart Contracts.
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