Decentralized Exchanges – How to Start a DEX
Learn the legal subtleties of starting a DEX: the possible need for a license, company formation, and legal set-up. LegalBison explores the benefits of running a decentralized exchange, dwelling on the legal side of the procedure.
- Legal assessment of the decentralized services
- Providing DEX-adapted legal services
- Technical assistance and audit
- Assistance with banking for providing on-ramping
Common services of DEXes and their regulation
A decentralized cryptocurrency exchange (DEX) is a peer-to-peer trading platform without any central authority to oversee and control the transactions. Instead, users trade cryptocurrencies through smart contracts.
Such a trading process is considered more individual and anonymous compared to trading on a CEX since all transactions go through on public blockchains, while the absence of a supervising body allows users to manage the custody of their funds.
The question that arises naturally is: how to legally structure a Decentralized Exchange?
Even for a decentralized platform, there are certain legal implications to be studied and possible requirements to be followed. As you read further, we will acquaint you with the building blocks of a decentralized exchange, explaining each not only from a legal but also a technical point of view.
- Operations
- Liquidity
- Wallets
- DAO
Describing the business model
One might assume that if a DEX is not governed by anyone in particular and gives its customers free rein in trading operations, it will not need a legal permit. This is not necessarily true. Assessing the need for a license starts with defining the business model of your future startup.
While some decentralized exchanges are crypto-only, which means that they allow customers to connect their wallets and use cryptocurrencies for trading directly from there, others can offer more flexible solutions, such as on-ramping for the trading process. On-ramping involves exchanging fiat currencies for digital ones to further use them on a DEX.
The involvement of fiat in a Decentralized Exchange is a prerequisite for licensing in its own right.
Managing liquidity
Liquidity is an aspect of huge importance in the stability of a DEX. Since decentralized exchanges connect traders directly to liquidity pools, without stable liquidity, it would be impossible to perform successful trading operations. A good example of the importance of liquidity is on-ramp services: a Decentralized Exchange that offers on-ramping must be able to find the liquidity to provide all customers with crypto in exchange for fiat.
Multiple factors contribute to stable liquidity. It is often managed by ensuring a sufficient number of trading pairs supported by the platform. For this purpose, it is important to evaluate which crypto trading pairs are the most popular among customers. Besides, do not forget about market making, which is the concept of active selling and buying cryptocurrencies that helps provide and support liquidity. This process can be facilitated by using Automated Market Makers (AMMs), the decentralized protocols that rely on algorithms to ensure direct and effortless crypto trading and sufficient liquidity.
Connecting crypto wallets
Decentralized exchanges do not hold custody over their clients’ funds. Instead, traders connect their crypto wallets to the platform and use them directly for trading after obtaining an individual private key. The process usually takes less than a minute and does not require any additional information from the trader whatsoever. Once a user wants to trade cryptocurrency, the DEX connects them to a corresponding liquidity pool.
An important technical aspect of this process is connecting crypto wallets. As a future owner of a Decentralized Exchange, you must think in advance of the crypto wallets that your platform will support. As a rule, it would be wise to concentrate on the most widely used ones, the crypto wallets that have gained client trust around the world and in the country with your particular targeted market. For instance, you could consider Metamask, a wallet that is tremendously popular among seasoned crypto traders.
Forming a Decentralized Autonomous Organization (DAO)
If a Decentralized Exchange has no central authority, then who draws policies and makes changes? Most often, a Decentralized Autonomous Organization (DAO) is behind the decision-making process. A trading platform can either create its own DAO before launch or enter a partnership with an already existing DAO. In this way, it will obtain a decentralized legal structure based on a set of smart contracts, in which traders will participate by purchasing DAO’s governance tokens.
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Examples of LegalBison's assistance with decentralized exchanges
LegalBison regularly assists clients with opening DEX platforms. Due to years of experience, we are able to define the best course of action for each individual project. In this section, we aim to demonstrate how exactly we put our knowledge of the matter into practice.
Assessing the legality of a DEX
As soon as LegalBison is provided with all the project details, our FinTech lawyers start assessing it from multiple legal perspectives. The assessment includes the business model and services that a Decentralized Exchange intends to provide, their legality in the targeted markets, and the need for a license.
Once the estimation is done, LegalBison can draft a legal opinion or memorandum that outlines the best approach to launching a DEX in a legally compliant way.
Crypto license for a DEX
Through the process of drafting a legal opinion, the experts might define that certain business models in the project are subject to licensing. In most cases, a Decentralized Exchange will require a crypto license, especially if its services are closely related to fiat (on-ramping).
Once the necessity arises, LegalBison undertakes the administrative side of licensing a company, providing all the required documentation, and interacting with a regulator on the client’s behalf.
Banking assistance
There are two possible types of banking assistance that LegalBison can provide: opening a bank account for the company itself and its corporate expenses and ensuring a banking gateway for clients’ transactions in fiat.
Due to the riskiness and increased volatility of the crypto market, most banks have second thoughts when it comes to working with crypto businesses. LegalBison established a connection between a client and a bank, ensuring that all the banking needs of the client are met.
Ongoing legal support
In an ongoing partnership with LegalBison, we will assist with all the legal matters such as incorporation and structuring. At the same time, if the lawyers assist your company with the license obtainment initially, they will stay by your side to provide prompt consultations and bridge any possible compliance gaps whenever needed.
Legal implications of a DEX
Assessing the need for an authorization (crypto license)
In most cases, a DEX platform will not require a license. However, it depends on the business model and technical subtleties of a particular project. One of the defining elements is the addition of on-ramp trading. If you plan to implement on-ramping within your Decentralized Exchange, then it will most likely require a crypto license. That license is also required for the subsequent custodial services provided on your exchange if you will detain the funds of your customers.
From the legal perspective, it means dealing with all the preparatory procedures and meeting the requirements of a regulatory authority. LegalBison’s know-how allows us to effectively analyze the most suitable regulator for a particular DEX project. Contact us with your project plan and the legal experts will draft a legal opinion or memorandum specifying the licensing needs for each aspect of your Decentralized Exchange.
AML-CFT and KYC procedures
With the need for a license comes a meticulous process of meeting AML-CFT and due diligence requirements. For AML-CFT compliance, most regulators require licensees to draft an adequate compliance program, as well as assign a responsible AML officer. LegalBison excels at ensuring AML compliance for clients, taking up all the necessary paperwork, and providing compliance trading for key shareholders.
In addition, the due diligence process is an integral part of the compliance procedure. For on-ramping, it is essential to provide a banking gateway, and banks tend to verify their clients before accepting transactions. In the case of a Decentralized Exchange, the KYC process will be the platform’s responsibility, as required by the majority of regulatory authorities.
Company formation for a DEX
Once LegalBison defines whether a project needs to be licensed or not through a legal opinion, the process of company formation starts. Company formation is an integral part of the project preparation and is recommended even for startups with no need for licensing. The experts take into account all the major and minor details of the future DEX, including business models and the extra elements, such as staking, lending, or deposits on liquidity pools.
Technical infrastructure
Proper technical set-up and cybersecurity are essential regardless of the licensing requirement. However, ensuring security at a DEX is way simpler compared to its CEX counterpart. Since the platform doesn’t keep custody of clients’ funds and traders exchange crypto pairs from their connected wallets, interacting directly with liquidity pools, the only possible way to ensure security is by approving only safe, verified, and reputed crypto wallets to be connected to your Decentralized Exchange. Another essential component of the technical set-up is a proper smart contract audit, which must be performed by professionals.
- Legal Assessment
- Compliance
- Incorporation
- Technical Audit
Assessing the need for an authorization (crypto license)
In most cases, a DEX platform will not require a license. However, it depends on the business model and technical subtleties of a particular project. One of the defining elements is the addition of on-ramp trading. If you plan to implement on-ramping within your Decentralized Exchange, then it will most likely require a crypto license. That license is also required for the subsequent custodial services provided on your exchange if you will detain the funds of your customers.
From the legal perspective, it means dealing with all the preparatory procedures and meeting the requirements of a regulatory authority. LegalBison’s know-how allows us to effectively analyze the most suitable regulator for a particular DEX project. Contact us with your project plan and the legal experts will draft a legal opinion or memorandum specifying the licensing needs for each aspect of your Decentralized Exchange.
AML-CFT and KYC procedures
With the need for a license comes a meticulous process of meeting AML-CFT and due diligence requirements. For AML-CFT compliance, most regulators require licensees to draft an adequate compliance program, as well as assign a responsible AML officer. LegalBison excels at ensuring AML compliance for clients, taking up all the necessary paperwork, and providing compliance trading for key shareholders.
In addition, the due diligence process is an integral part of the compliance procedure. For on-ramping, it is essential to provide a banking gateway, and banks tend to verify their clients before accepting transactions. In the case of a Decentralized Exchange, the KYC process will be the platform’s responsibility, as required by the majority of regulatory authorities.
Company formation for a DEX
Once LegalBison defines whether a project needs to be licensed or not through a legal opinion, the process of company formation starts. Company formation is an integral part of the project preparation and is recommended even for startups with no need for licensing. The experts take into account all the major and minor details of the future DEX, including business models and the extra elements, such as staking, lending, or deposits on liquidity pools.
Technical infrastructure
Proper technical set-up and cybersecurity are essential regardless of the licensing requirement. However, ensuring security at a DEX is way simpler compared to its CEX counterpart. Since the platform doesn’t keep custody of clients’ funds and traders exchange crypto pairs from their connected wallets, interacting directly with liquidity pools, the only possible way to ensure security is by approving only safe, verified, and reputed crypto wallets to be connected to your Decentralized Exchange. Another essential component of the technical set-up is a proper smart contract audit, which must be performed by professionals.
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The team of LegalBison was very helpful and fast in supporting my company’s structural set up. They are undoubtedly top-level experts when it comes to licensing and registrations in the crypto and web3 industry. Highly recommend!
Very proactive, responsive, and able to provide solutions and advice. The firm is familiar with the new industry of blockchain and cryptocurrency
Guiding questions for your DEX legality
Pay attention to the six questions below, which are designed to guide you on the key aspects of starting a DEX. If you don’t have an answer to all of them, our legal experts are ready to assist you today.
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FAQ about our legal assistance for the set up of decentralized exchange platforms
Yes, but a consultation with a legal professional is highly advisable. The lawyers at LegalBison can take your project to work and assist you with starting a DEX in a legally compliant manner.
For starters, understand the business model of your project and the legal intricacies connected to it. This is best done through making a legal opinion, in which expert lawyers will analyze your project and define its needs from A to Z.
The price of launching your own Decentralized Exchange platform will depend on the business model, legal implications, and possible need for authorization. We advise you to contact us directly for more detailed information about your particular project. We can communicate through phone calls or messaging apps texting, as per your preference.
Yes, it is possible to incorporate on-ramping services to your clients on your decentralized platform. However, this implies connecting your project to the banking system. LegalBison can advise you on such solutions, in order to offer crypto on and off ramping to your customers.
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Contact us now and our team wil consult you on the corporate structure of your DEX project.
Our experts will guide you on the legal implications of setting up a decentralized exchange and help you draw a roadmap. The first consultation is free.
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