Crypto Trading Crypto Trading DeFi and Exchanges 1 — Questions and Answers
Question 1: What is a decentralized exchange (DEX)?
- An exchange operated by a government financial authority
- A peer-to-peer trading platform that operates via smart contracts without a central intermediary (Correct answer)
- An exchange that only lists Bitcoin and Ethereum
- A platform that stores user funds in a centralized vault for security
Correct answer: A peer-to-peer trading platform that operates via smart contracts without a central intermediary
A DEX uses smart contracts to facilitate peer-to-peer trades directly from users' wallets, eliminating the need for a centralized custodian.
Question 2: What is an Automated Market Maker (AMM) in DeFi?
- A bot that automatically places trades on behalf of users
- A smart contract-based liquidity protocol that uses mathematical formulas to price assets instead of an order book (Correct answer)
- A government-approved algorithm for setting crypto prices
- A tool that automatically rebalances a crypto portfolio
Correct answer: A smart contract-based liquidity protocol that uses mathematical formulas to price assets instead of an order book
AMMs like Uniswap use constant-product formulas (x×y=k) to determine prices based on the ratio of tokens in a liquidity pool rather than using a traditional order book.
Question 3: What is 'impermanent loss' in DeFi liquidity provision?
- A permanent loss of funds due to a smart contract hack
- A temporary reduction in value that liquidity providers experience compared to simply holding assets when prices diverge (Correct answer)
- The fee charged by a DEX for removing liquidity
- The loss caused by high gas fees on Ethereum
Correct answer: A temporary reduction in value that liquidity providers experience compared to simply holding assets when prices diverge
Impermanent loss occurs when the price ratio of pooled assets changes after deposit, making the dollar value of the LP's share less than if they had just held the tokens.
Question 4: What is the primary function of a liquidity pool in DeFi?
- To store private keys for users securely
- To provide the reserves of tokens needed for a DEX to execute trades without a counterparty (Correct answer)
- To lock tokens and prevent market manipulation
- To distribute staking rewards to validators
Correct answer: To provide the reserves of tokens needed for a DEX to execute trades without a counterparty
Liquidity pools hold token reserves supplied by LPs, enabling the AMM to fill trades instantly without needing a matching buyer or seller.
Question 5: What is a 'gas fee' in the context of Ethereum-based crypto trading?
- A fee paid to miners for electricity used to cool their equipment
- The transaction fee paid to Ethereum validators for processing and including a transaction on the blockchain (Correct answer)
- A monthly subscription fee charged by DeFi platforms
- A penalty fee for canceling a limit order on a DEX
Correct answer: The transaction fee paid to Ethereum validators for processing and including a transaction on the blockchain
Gas fees compensate Ethereum validators (formerly miners) for the computational resources required to execute transactions and smart contract operations.
Question 6: What distinguishes a centralized exchange (CEX) from a DEX?
- CEXs only support fiat-to-crypto trading while DEXs support crypto-to-crypto only
- CEXs hold user funds in custodial wallets and use internal order books, while DEXs let users trade directly from self-custody wallets via smart contracts (Correct answer)
- CEXs charge no trading fees while DEXs charge high fees
- CEXs operate on public blockchains while DEXs operate on private servers
Correct answer: CEXs hold user funds in custodial wallets and use internal order books, while DEXs let users trade directly from self-custody wallets via smart contracts
On a CEX, the exchange takes custody of user assets and manages the order book; on a DEX, users retain custody and trades settle on-chain via smart contracts.
Crypto Trading Crypto Trading DeFi and Exchanges 1
What is a decentralized exchange (DEX)?