The evolution of decentralized exchange: Risks, benefits, and oversight

Abstract

A decentralized exchange, or DEX, is an application deployed on a blockchain that allows investors to exchange digital assets. We focus on the most prominent type of DEX, an Automated Market Maker (AMM), where at pricing terms are determined by a preset exchange rate formula. This technology has several unique features, including accessibility to all investors, transparency of pricing, and near simultaneity of execution and settlement. In particular, trading via a DEX is feasible for any asset tokenized on a blockchain. In turn, given that assets such as stocks and bonds could be easily tokenized, it is particularly important to understand the risks posed by DEXs. This paper examines both the benefits and risks for investors from DEXs, explores the role of private and public liquidity pools, and analyzes possible regulatory approaches.