DEX vs CEX: An Informational Guide to Crypto Exchanges
If you are a crypto newbie or an expert, you might have heard of the two terminologies in the crypto world: decentralized exchanges (DEX) and centralized exchanges (CEX). Cryptocurrency investors are using these two terms interchangeably. However, they are pretty different in their own right. In this article, we will be shedding some light on the differences between the two.
What Are Crypto Exchanges?
In the crypto context, an exchange is a platform that facilitates trades of cryptocurrencies. These trades are nothing but changes in the ownership of cryptocurrency tokens. Every time a trade happens, someone buys, and someone sells. This changes the ownership of the tokens involved in the transaction.
History of Cryptocurrency Exchanges
Cryptocurrency exchanges have been around for years now. However, a lot had changed since the early days when they mainly served as marketplaces for Bitcoin. These days, hundreds of tokens are being traded across various markets, all happening on different cryptocurrency exchanges.
The history of cryptocurrency exchanges is a short one. Bitcoin launched in 2009. In the beginning, there was no formal exchange for trading it. Instead, there were a few early adopters trading amongst themselves. It wasn’t until 2011 that the first cryptocurrency exchange emerged. MtGox, and many others, later followed.
These early exchanges were all centralized. They acted as marketplaces where traders could store their cryptocurrencies. They could also trade with one another. However, it became clear that these centralized entities weren’t without their faults. The biggest of them, MtGox, suffered a major hack in 2014, resulting in the loss of 750,000 BTC, worth $350m at the time.
In response to hacks like these, developers began working on new kinds of exchanges; exchanges that would be as decentralized as Bitcoin itself. The first decentralized cryptocurrency exchange to launch was Bitsquare (now Bisq) in 2016. Since then, there have been many more projects developing. Some examples include DEXs such as EtherDelta and Radar Relay.
Decentralized Exchanges (DEX) vs Centralized Exchanges (CEX)
Two types of platforms offer to trade cryptocurrencies. Centralized exchange (CEX) is where you deposit your coins into an account. That account gives you an IOU for what you deposited into it. That CEX can then manipulate the numbers in your IOU to make money for itself, similar to how a traditional bank would do. It can also block your account or do anything with the IOU. In contrast, Decentralized exchange (DEX) is where there is no third-party intermediary. Instead, you are trading coin for coin without any centralized third party involved.
What Is a Centralized Exchange (CEX) and How Does It Work?
A centralized exchange (CEX) is a digital asset exchange. It provides its services on a centralized basis. In other words, the users always make deposits to or withdrawals from the exchange’s wallet instead of the users’ wallets. In addition, centralized exchanges act as intermediaries between buyers and sellers, offering a wider variety of cryptocurrencies to trade.
This exchange relies on a third-party service to hold the customer’s funds. Users must first deposit funds into the platform before they are allowed to trade, similar to using a stock brokerage account. As ‘banking’ institutions, they hold private keys. In theory, the user is no longer in control of their assets.
CEXs typically offer their customers a good selection of altcoins and tradable pairs. Some even offer hundreds of tokens not yet available on decentralized exchanges (DEXs). Moreover, new traders readily adopt these centralized services with several convenient deposit methods, such as credit cards and bank wire transfers.
For a centralized exchange to work, it must hold custody of the users’ assets, including those who want to trade with one another. These centralized exchanges are built on top of a given blockchain. However, they do not provide access to underlying blockchains directly by design. Therefore, the user must trust the exchange to correctly manage their assets and execute transactions.
Advantages Centralized Exchanges (CEXs)
Secured Platform: A centralized exchange allows users to deposit funds via a bank account or credit card, giving them an added layer of security from regulation.
Practicality: CEXs usually own your private keys. Thus, if you forget your password or username, you can still recover access to your account. Also, CEXs tend to have an interface similar to traditional banking platforms, making it easier for beginners in crypto.
More Trading Options: CEXs offer greater liquidity by providing more trading options than DEXs. Some centralized exchanges even offer advanced features like margin trading, providing extra value for the traders looking for an edge.
Disadvantages of Centralized Exchanges (CEXs)
Trust Issues: The most significant disadvantage of using a centralized exchange is trust. This leaves a single point of failure, so to speak. In addition, most centralized exchanges collect personal information since they require a KYC process. The KYC process gathers information like your ID, name, address, and more, which not everyone is comfortable with providing. They also have power over users’ assets, which is what many wish to flee when investing in crypto.
High Risk of Hack: Another disadvantage of CEX is the increased risk involved. Since CEXs have large amounts of assets centralized and own all private keys, they are big targets for hackers. In these hacks, which already happened, users can lose funds and have personal information exposed.
Limited Access: A common drawback of some centralized exchanges is that they’re not open for trading 24/7, with some coins only being traded during certain hours. But this is not usually the case within crypto since markets are always open, and the most popular exchanges accommodate that.
Higher Fees: CEXs tend to charge higher fees compared to DEXs.
What Is a Decentralized Exchange (DEX) and How Does It Work?
A decentralized exchange (DEX) is a cryptocurrency exchange that does not rely on a third-party service to hold the customer’s funds. Instead, trades occur directly between users (peer-to-peer) through an automated process. While DEXs might use their order books, they differ from CEXs, which match exchanges between users.
Another crucial aspect of DEXs is that it is non-custodial. In the crypto-blockchain industry, non-custodial services are those where the users retain complete control over their assets. However, users also need to manage their private keys, which are specialized algorithmic passwords. Being a non-custodial service also implies that no external entity must manage, insure, and transact the assets held.
This non-custodial nature makes DEXs a bit trickier to hack in theory because there is no single point of failure. Also, the funds stored within cannot be seized or stolen by any external entity. This makes them far more secure than centralized exchanges and highly censorship-resistant. Finally, DEXs give users complete control over their funds, allowing them autonomy over their assets. And DeFi teams are capitalizing on this non-custodial world by building innovative projects that the traditional finance space has yet to see.
Liquidity Pools and AMMs
It wasn’t until recently that DEXs became competitive with their centralized counterparts. That’s partly due to the emergence of automated market makers (AMMs). Automated Market Makers are algorithmically driven and the trades executed are based on the amount of supply and demand in the liquidity pool.
A liquidity pool is a pool of funds contributed by token holders locked by a smart contract. In simpler terms, users contribute funds to a digital collection, and those are used to facilitate trades on the DEX. It accomplishes this by ensuring there is enough liquidity to match orders at all times, thus completing transactions quickly.
Advantages of Decentralized Exchanges (DEXs)
Decentralized exchanges are built on a blockchain and leverage the host chain’s key features. As a result, they can be highly appealing for a few reasons:
Security: On a DEX, users are not required to transfer their assets to the exchange’s wallet. Instead, all trades occur directly between users (peer-to-peer). This eliminates any risks associated with the mishandling of funds. It can also protect users from hacks, which are more common in DEXs.
Privacy: When trading on a DEX, there is no need to provide the platform with personal information, unlike centralized exchanges. This allows for more privacy and anonymity when trading digital currencies.
Control: Users are always in control of their private keys and funds on a decentralized exchange. This is opposed to having your funds stored on a centralized server, where they can be frozen or seized by the exchange.
Disadvantages of Decentralized Exchanges (DEXs)
Lack of Fiat Payments: Unlike CEXs, you can’t trade fiat currencies (e.g., US dollar, Euro) on DEXs. Users have to own cryptocurrencies already to trade on decentralized exchanges.
Liquidity: A significant drawback of decentralized exchanges is the lack of liquidity. They have fewer users than centralized platforms. Thus, finding buyers and sellers for certain assets can be challenging.
No Back-Up Access: One of the main benefits of DEXs can also be seen as a disadvantage for some users. It’s the fact that users own their private keys, and if they lose them for some reason, there is no way to recover their wallets. CEXs, on the other hand, offers ways for users to recover their assets if they forget their access keys. Therefore, users must make sure they have the private keys of their wallets saved in a secure place.
Main Differences Between a CEX vs. DEX
The main difference between a CEX and a DEX is simple: the former serves as a third party between trades, while the latter only offers the platform to connect traders. This simple distinction is reflected in several differences:
|Account Opening||Verification of identity, KYC, AML||Anonymous with no verification|
|Security||Managed by exchange, covered by regulations, but more prone to hacks||User manages their own security (wallet, private keys, etc.)|
|Censorship||It can occur from the exchange, banks, and government regulations||Censorship-resistant|
|Custody of Assets||Exchange has custody of assets on its platform||Self-custody of wallet, control over assets|
|Order books||Market makers||AMM (automated market makers)|
|Trading Hours||Limited, some coins can only be traded in specific timeframes||24/7|
|Fiat Trading||Available||Not available|
DEX vs. CEX: The Future of Crypto Trading
Decentralized exchanges offer numerous benefits to the financial sector; however, they still can improve more when compared to their centralized counterpart. DEXs provide lower fees, more security, anonymity, and control over assets. However, they also present challenges, namely usability, and liquidity.
As decentralized exchanges become easier to use, centralized exchanges may see users leave and opt for the non-custodial option. The future should be exciting for both kinds of exchanges. We’re excited to be here early and continue to build!