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I am trying to understand the concept of crypto exchanges (AMM / DEX).

On a DEX on Ethereum, how is it possible to trade tokens that are not native to Ethereum, such as Bitcoin? How does the DEX interacts with the Bitcoin blockchain?

Does it use any smart contract or any particular method?

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  • Are you asking how DEX work in general, or more specifically how can a DEX make a swap between tokens that are not on the same blockchain such as ETH and BTC?
    – Undead8
    Commented Jun 5, 2021 at 23:40
  • yes, How is swap work that is not in the same blockchain?
    – naga
    Commented Jun 6, 2021 at 5:22

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If you use a DEX on a blockchain like Ethereum or Binance Smart Chain (BSC), the DEX can only interact with tokens that are created on that particular blockchain. Ethereum does not "talk" to other blockchains such as Bitcoin and BSC, and vice-versa. In other words, an Ethereum transaction cannot modify the state of the bitcoin blockchain, they are both independent of each other.

So how come bitcoin, doge coin and all those foreign tokens can be traded on Ethereum DEXes?

The answer is that they are wrapped tokens.

In short, someone put X amount of bitcoins in a reserve account on the bitcoin blockchain and issued an ERC-20 token on Ethereum with X tokens in circulation (such as WBTC). The ERC-20 tokens can be exchange 1 to 1 for the bitcoins in the reserve account. The DEX will trade the ERC-20 token only, not the tokens on the native blockchain reserve. Here is a more detailed explanation by Binance.

Wrapped tokens are generally somewhat centralized, meaning that some entity somewhere has the private key to the native blockchain reserve (the bitcoin account in my example). Consequently, they carry an additional risk compared to holding the native token directly.

An exception to this is when a token is wrapped on the same blockchain where it is issued. An example would be ETH - WETH, and BNB - WBNB. These wrapped tokens are wrapped by a smart contract not controlled by anyone.

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  • Thank you for replay.How about Centralised exchange CEX, this applies to centralised exchange also ? In centralised exchange also they use wrapped token.
    – naga
    Commented Jun 7, 2021 at 4:31
  • With CEX, you send tokens to an address that they control on the native blockchain and they add this amount of tokens to your account on their website. However, they control the tokens on the blockchain, not you. Some DEX like Binance accept wrapped tokens instead of the native, some don't.
    – Undead8
    Commented Jun 7, 2021 at 12:37
  • Thank you, can i have any link or research paper, you would recomand for me on CEX exchange.
    – naga
    Commented Jun 7, 2021 at 15:05

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