How to Build a Decentralized Exchange (DEX) Like Uniswap

In this blog post, we shift our focus to the dynamic landscape of the cryptocurrency market, zeroing in on the pivotal role played by Decentralized Exchanges (DEXs).

How to make a decentralized exchange (DEX): Highlights

DEXs, a decentralized application with built-in economic functions, offer crypto enthusiasts different ways to think about asset trading, without giving up custody of their crypto.

• Decentralized exchanges operate under a mechanism that allows users to contribute liquidity to the platform, creating a pool for others to trade. Each trade incurs a trading fee subsequently directed to the individuals who have supplied liquidity to the platform;
• Unlike centralized exchanges governed by a company or organization, DEXs rely on the code to maintain their functionality;
• Smart contracts rule the pool with mathematical precision in order to facilitate trustless and immediate trading;
• Uniswap, a prominent player in the DeFi arena, establishes industry benchmarks, serving as a guiding beacon for developers to glean insights and inspiration;

Join us as we navigate through the process of how to create a decentralized exchange with the help of GetBlock services. We will also uncover what decentralized exchange is, how it works on the example of Uniswap, and what to consider before diving into this venture of building your very own DEX.

What are Decentralized Exchanges (DEXs)

In the world of decentralized finance, users engage in asset trading by interacting with liquidity pools, facilitated by smart contracts. Given the pivotal role of smart contracts in upholding DEX functionality, these exchanges can be succinctly defined as decentralized applications (dApps) operating on programmable blockchains, such as Ethereum and its EVM-compatible counterparts.

Here's where the magic happens: users gain the power to supply liquidity for any token, enabling instant trading while earning a share of the fees paid by fellow traders. Incentivizing liquidity providers, this model encourages them to lock their funds and sustain the reserves, fostering a dynamic and liquid trading environment.

Image by Appinventiv

Aside from trading, many platforms embrace all kinds of DeFi services facilitating staking, lending, and yield farming to name a few.

How does a DEX differ from a centralized exchange?

Centralized cryptocurrency exchanges (CEXs) are not inherently different from traditional financial institution services. They accept deposits, hold them in custody, and allow users to trade inside their database offering services of matching demand and supply between crypto investors.

While an intermediary ensures both parties stay committed to their side of the bargain, they also hold the power to assess the deposits coming in and restrict withdrawals based on their compliance policy.

DeFi, on the other hand, establishes peer-to-peer marketplaces where investors shape the market, free from centralized control. DEXs are often viewed as reliable sources for asset acquisition considering it’s purely governed by a code, i.e. smart contracts.

Another significant difference between CEX and DEX is the custodial character of centralized exchanges as they also act as storage for user funds, while with decentralized platforms funds are deposited directly to user wallets.

Advantages and disadvantages of DEXs

Decentralized finance products are gradually capturing their audience and adapting to user preferences. However, the complexity of using DEXs often hinders the widespread adoption. Despite this challenge, the compelling advantages of these services continue to attract users.

To start with, users retain custody of their funds, generating and distributing value among themselves without the risk of restriction. Moreover, no personal information is required to be revealed as users only need a cryptocurrency wallet to participate.

This self-reliance eliminates the need to trust a centralized entity for fund management, reducing the vulnerability of assets to potential hacker attacks. More benefits and drawbacks are listed in the table below.

#	Category	Pros	Cons
1	Availability	Increased selection of tokens	No fiat trading involved; Risks of lower liquidity compared to centralized counterparties
2	Security	Eliminating middlemen and third-party frauds	Traders are solely responsible for asset security
3	User experience	The only requirement to connect a crypto wallet promotes accessibility	Less streamlined user experience compared to CEXs
4	No-KYC policy	Full user control over assets and anonymous trading	Lack of dedicated support teams to resolve any issues
5	Transparency	Guaranteed by a decentralized ledger that keeps score of all the activity	Open-source code, potentially exposing contract vulnerabilities to exploitation by hackers

On the downside, decentralized exchanges offer an open invitation for anyone to provide liquidity, making tokens accessible to a broader audience. However, this inclusivity increases the chances of coming across unvetted projects.

Another significant concern revolves around potential smart contract vulnerabilities, which can pave the way for malicious activities. Therefore, it is imperative to conduct meticulous checks and audits when creating a DEX to safeguard user trust.

Why build a DEX?

Decentralized finance services have experienced a substantial surge in user demand over the past year, influenced in part by failures in centralized crypto exchanges. Traders, prioritizing the security of their funds, turn to trusted DEXs for a more secure alternative.

Image from DeFiLlama

Additionally, Uniswap's open-source code has paved the way for individuals to create more DEXs and extend the benefits of secure trading to a diverse range of blockchains.

Now that we've explored the growing demand for decentralized finance, let's review how to build a decentralized exchange leveraging the powerful services provided by GetBlock. We will also tap into a high-level overview of Uniswap's design for inspiration and review key points to consider in the process of creating your own DEX.

Planning your DEX

Before we embark on a journey to create our DEX, it's beneficial to understand the workings of major players and conduct research on existing exchanges. This section serves as a valuable resource for those curious about the operational dynamics of decentralized exchanges and provides developers with an overview of the design principles employed by similar applications.

Uniswap often comes to mind as the quintessential decentralized exchange, holding the top spot in the DeFi market cap according to CoinGecko. Let's now take a brief look at the key building components of the Uniswap dApp.

Image from Uniswap

It's worth noting that the platform has progressed to its third version and is actively working on introducing the fourth. However, for the purpose of our exploration, we'll focus on V2. This version implements a simpler architecture and has been successfully forked and utilized by many popular exchanges, including PancakeSwap.

The AMM Model
Automated Market Maker is a major DeFi primitive that powers decentralized exchanges as opposed to order books that are traditional for centralized financial platforms.

In the AMM system, users set up a liquidity pool or deposit to an existing pool. Whenever a trade occurs, liquidity providers (LPs) earn fees proportionate to the user’s share of that pool.

In Uniswap, it’s a portion of the protocol’s 0.3% trading fees. Since the volume that moves through the popular pools is substantial, even small-time liquidity providers can make a profit by just adding their crypto to the pool.

Image by Uniswap

Unlike the order book which only swings into action when there’s an overlap in the system, AMM is constantly active — the trades are managed around the clock without having to wait for a buyer or a seller to agree on a price.

Liquidity Pool and Liquidity Token
A Uniswap pool operates as a smart contract designed to "store" a specific quantity of reserves.
Liquidity providers (LPs) deposit a desired amount of asset X plus asset Y of equal value to a smart contract pool and form this reserve.

As a confirmation representing contributed liquidity, LPs provided liquidity tokens minted in return, which is gaining interest proportionate to fees traders charged. Withdrawing funds from a pool results in burning these tokens so that upon redeeming their LP tokens, users get paid the interest amount added to the initial deposit.

Smart Contracts
The terms of agreement between buyers and sellers participating in DeFi swaps are written into the code, providing more transparent and secure trading. From the smart contract perspective, DEX is made of a series of Solidity codes.

The smart contract system for V2 of Uniswap is intentionally made binary, comprising of Core and Periphery contracts. By adopting this approach, the developer team prioritizes security by minimizing the code in Core, focusing solely on essential features. Non-critical functions are relegated to Periphery, reducing the audit scope and enhancing overall security.

• Let’s briefly cover the ‘Core’ to understand how exchanges function from the inside:
  Liquidity token smart contract controls minting and burning. For reference, below is the code snippet defining the burning mechanism.

Image from Uniswap GitHub

• An exchange contract defines the main logic of depositing and withdrawing liquidity as well as swapping tokens. It also holds assets making up liquidity pools;

Image from Uniswap GitHub

• Factory contract holds a mapping of token addresses to their relevant trading pair exchange contracts and allows the deploying of new trading pair exchange contracts.

Image from GitHub

While this provides a general understanding of how Uniswap designs the app to function, delving into more details becomes imperative if you're looking to build a DEX of your own.

Building Your DEX

As we've unraveled the intricacies of the most popular DEX, let's plunge into the essential steps of constructing your own to give an idea of where GetBlock steps into the process of bringing your decentralized exchange to life.

Step 1: Setting up the development environment

1.1. Take care of installing necessary software and tools:

Crafting decentralized applications at this level demands proficiency in a code editor (e.g., Visual Studio Code), Node.js, npm, as well as a Hardhat for working on EVM-based smart contracts.

Consider exploring our Remix guide for a more streamlined development process that demands no prior preparations.

1.2. Sign up to GetBlock:

Create a free account on the GetBlock platform to obtain access tokens to leverage GetBlock's blockchain nodes for test launching and deploying the dApp.

Image by GetBlock

Following the setup, users can seamlessly access the free package, enabling communication with shared nodes. For those seeking enhanced power and scalability, dedicated nodes are also available, providing a robust solution for more resource-intensive applications.

Step 2: Choosing the right blockchain platform

One of the most important decisions to make is which blockchain platform to build your DEX on. Popular choices include Ethereum, BNB Smart Chain, or other EVM-based chains, depending on your specific needs.

zkEVMs have emerged as a prominent trend in decentralized space today. GetBlock, aligning with this trend, also offers seamless access to zkSync nodes and Linea RPC nodes for users to harness the advantages of low-cost transactions and lightning-speed Layer2 protocols, adding a new dimension of efficiency to their decentralized applications.

Step 3: Smart contract development

The next step involves writing smart contracts that handle the DEX functionalities, such as trading, order matching, and liquidity provision. GetBlock will help to deploy and test your code on a testnet to ensure it works as intended.

To do so, you may download the configuration file and save it to your working directory.

Image by GetBlock

To use it in Hardhat, navigate to the ‘hardhat.config.js’ within the project directory and import the getblock module by passing the following command:

const { getblock } = require('./getblock.config.js'); 

For instance, to configure GetBlock as a Sepolia node provider, adjust the Hardhat config file by as follows.

const { getblock } = require('./getblock.config.js'); 

module.exports = {
  defaultNetwork: "sepolia",
  networks: {
    hardhat: {
    },
    sepolia: {
      url: getblock.shared.eth.sepolia.rpc[0].go() // https://go.getblock.io//
    },
  },
  solidity: {
    version: "0.8.19",
    settings: {
      optimizer: {
        enabled: true,
        runs: 200
      }
    }
  },
  paths: {
    sources: "./contracts",
    tests: "./test",
    cache: "./cache",
    artifacts: "./artifacts"
  },
  mocha: {
    timeout: 40000
  }
}

Similarly, you can gain access to mainnet nodes and deploy the Solidity contract to Ethereum, as well as other EVM-compatible chains.

Step 4: Front-end development

Build a front-end application using technologies like HTML, CSS, and JavaScript or a front-end framework like React. Upon thorough testing, connect your front end to the smart contracts using web3.js (for Ethereum) or relevant SDKs for other blockchains.

Final thoughts

Decentralized Exchanges (DEXs) stand as a testament to the transformative power of blockchain technology, from the principles of decentralization to the intricacies of smart contract governance. Our shortest guide provides a high-level overview of the steps involved in making your DEX application involving GetBlock’s services for smooth on-chain deployment. However, the whole process is rather complex and requires in-depth studying to clearly understand the financial formulas involved in every process and what’s happening behind each contract.