The crypto world is expanding, and with the increasing hype, investors and traders are looking for platforms to trade and facilitate their purchases. Among the plethora of platforms the web offers, the two broad categories of crypto exchanges traders can opt for are centralized exchanges(CEXs) and decentralized exchanges (DEX). Let’s have a look at these.
DEX
A DEX stands for decentralized exchange. A decentralized exchange is a peer-to-peer marketplace where direct transactions occur between crypto traders. These exchanges fulfill a core possibility of crypto, i.e., fostering the financial transactions which are not officiated by intermediary third parties like banks, payment processors, and brokers. DEXs don’t permit exchanges between fiat and crypto, unlike centralized exchanges. They facilitate the trading of cryptocurrency tokens for other cryptocurrency tokens.
Uniswap and Sushiswap- two of the most popular DEXs- are based on the Ethereum blockchain and form a part of DeFi, an abbreviation for decentralized finance.
DEXs are gaining more popularity day by day. $217 billion in transactions flowed via decentralized exchanges in the first quarter of 2021. The number of DeFi traders has also increased substantially over the years. DEXs reported a trading volume of more than $1 trillion in 2021, depicting an increase of 858% compared to that in 2020.
CEX
A CEX or a centralized exchange is a platform operated by companies/organizations that own them, i.e., they operate in a centralized manner. These exchanges facilitate trade between users via an order book. These order books are a collection of purchase and sell orders posted by traders.
The request to buy or sell a given amount of cryptocurrency at a price is an order. CEXs collect these orders from people and then use curated softwares to match and disband the complementing buy and sell orders.
The users of CEX do not exchange fiat currencies or crypto with one another. When one deposits their funds on an exchange platform, it takes custody of the deposited assets and issues the corresponding amount of IOUs (Investor-owned utilities) to the trading party. Users’ IOUs are internally tracked as they change trading hands. They are converted to actual currency only when the funds are withdrawn.
The cost-efficient and speedy processing of transactions by a single point of authority make them convenient for investors and traders alike. However, CEXs’ reliance on a central authority has certain disadvantages. A lack of transparency enables exploitation and malicious practices like price manipulation and wash trading. In 2019, the market lost customer funds worth more than $292 million in just the 12 biggest CEX hacks in that year.
DEX versus CEX: What is the difference?
As the name suggests, CEXs are operated by centralized authorities, while users and liquidity providers operate via DEXs. This basic difference forms the foundation of several differences between the two platforms.
Source: https://academy.aax.com/en/the-evolution-of-exchanges-from-traditional-to-cex-and-dex/
Custody of assets
CEXs control the access to all crypto assets invested. Before one starts trading, all the assets have to be placed in the custody of the platform, while in a DEX, users have complete control over their assets. However, since DEXs are non-custodial, the demand for the security of private keys increases.
Impermanent loss
DEXs provide a neat system for trading and provide the facility of liquidity pools to its users. However, this advantage comes with possible risks. Liquidity providers are exposed to the risk of impermanent loss in decentralized exchanges. They can only withdraw their share in the value of the liquidity pool instead of the number of tokens they invested in it.
Safety Mechanisms
The popularity of DEXs has been high, but they lack safety mechanisms. DEXs do not require the users to comply with KYC requirements. Traders can start trading on a DEX by integrating their crypto wallet with the platform.
Autonomous operations of DEXs free them of any concern about AML procedures or KYC verification. However, this poses a drawback to investors as the traders are prone to fraud and scams. On the other hand, CEXs have numerous safety features such as KYC registration, 2-factor authentication, etc.
Trading Options
CEXs offer a wide range of trading options which include multiple trading options, including futures and spot trading, among others. DEXs are limited to crypto borrowing and lending and speculative investments.
Also, CEXs offer a limited number of crypto trading pairs based on their due diligence and market standing. DEX, though, provides greater access to a much wider variety of coins as coins can be freely listed on these exchanges. However, this poses risks for the investors if the cryptos are scams or illiquid.
Liquidity
Since CEXs possess a large user base, they have higher liquidity. The lack of due diligence and competition from CEXs reduce the liquidity of DEX platforms. New and emerging DEXs cannot compete with well-established CEXs in terms of liquidity. However, new aggregator and compliance protocols appear to be a potential solution to the liquidity problem on DEXs.
Security
Decentralized exchanges are comparatively more secure than their centralized counterparts since they are non-custodial. Hackers target exchanges to access the central database and extract the private keys of account holders. DEXs don’t hold any of the private keys, eliminating the possibility of user wallets getting hacked. No identity checks are done on DEXs hence it rids the risk of leaking private user data.
At the macro level, though, DEXs have been worst affected by hacks and exploits recently, while CEXs remain a safer bet as they are less prone to hacks and exploits targeting the platform’s source code.
CEX or DEX: What should I trade on?
As is visible from the above comparison, DEXs emerge as a better and easier alternative to centralized exchanges, given the variety of options, greater control over our holdings, and easy onboarding. However, DEXs are less liquid and more prone to security risks.
On the other hand, CEXs score points in a smooth and user-friendly interface and security. CEXs are the first entry point for anyone interested in exploring crypto and its vast world in the current scenario.
CEXs form an easier and faster option for beginners in crypto trading, while DEXs are better for experienced traders looking for security and complete control over their funds. The choice, however, will depend on the individual trader and their trading goals.
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