By
Grace
September 14, 2022
4 Min Read
Crypto trading is gaining more and more popularity, enabling traders to buy and sell different tokens that can be later utilized for a variety of purposes. Currently, there are two dominating types of platforms facilitating cryptocurrency trading - DEXes (decentralized exchanges) and CEXes (centralized exchanges). Let’s dive into the intricacies of the CEX vs DEX debate and explore each in detail.
Let's explore the CEX vs DEX debate by examining each type of exchange separately.
CEXes are similar to traditional stock exchanges and are the original type of trading platform for crypto asset traders and investors. As the name suggests, they are reliant on a central authority or a centralized organization for the exchange of crypto assets. Some of the most popular platforms in that space include Coinbase, Binance, Kraken and Gemini.
Normally, a centralized exchange functions on the backbone of order books. The order book stores data on every trader’s buy or sell order placement along with the specified crypto amount and the desired buy or sell price. Matching buy and sell orders are paired, enabling the trade to be executed.
CEXes may still dominate the crypto exchange space, but they are not without drawbacks, as we’ll discover later on in this article. DEXes were designed to address the limitations of CEXes and provide crypto traders with access to a decentralized way of exchanging crypto assets.
DEXes are a type of crypto trading platform that has emerged to provide an alternative way of trading cryptocurrencies that does not require third-party involvement. We’ve covered DEXes in detail in another article that we invite you to read. In a nutshell, instead of depending on centralized authority, decentralized exchanges rely on smart contracts for the execution of trades.
Some of the most popular decentralized exchanges today include Uniswap, Sushiswap, and Curve Finance. It’s also worth noting that not all DEXes are the same. Some utilize the order book method described above, while others are created as Automated Market Maker (AMM) structures or designed in the form of DEX aggregators. These crypto trading platforms may have expanded on the capabilities of centralized exchanges, but they too come with a set of limitations.
So far, we’ve uncovered a few important points of differentiation between decentralized and centralized exchanges. However, the CEX vs DEX dilemma goes further than that.
To fully understand the contrast between these two types of crypto exchanges, it’s important to explore certain features in detail.
It’s impossible to define decentralized and centralized exchanges without instantly pinning down the fundamental distinction between the two - governance. As already mentioned, DEXes are fully decentralized, with reliance on users and liquidity providers and zero dependence on financial regulators. On the other hand, CEXes are governed by centralized, for-profit authorities and based on internal structures and independent IT infrastructures.
Decentralization is precisely what makes blockchain technology unique and аdvantageous. Therefore, it's a key component in the CEX vs DEX comparison.
Another key difference that pops up when exploring the CEX vs DEX topic is liquidity. One of the problems with decentralized exchanges is their low liquidity, which makes it difficult to attract large traders to these platforms. Creating liquidity remains a challenge, despite attempts to find a solution in the face of liquidity pools and different AMM liquidity models.
Currently, centralized exchanges outperform DEXes with more users and higher levels of liquidity.
Cryptocurrency exchanges are beholden to regulations that may vary greatly from one jurisdiction to the next. In the USA, for example, crypto trading platforms are regulated by the Bank Secrecy Act (BSA). However, because of their decentralized nature and anonymous operations, decentralized exchanges are currently subject to little regulatory scrutiny. While CEXes must abide by Know Your Customer (KYC) and anti-money laundering (AML) standards, DEXes are currently enjoying far greater leniency in that regard.
This enables decentralized exchanges to offer traders anonymity and to enjoy more flexibility.
Following the points we made regarding CEX vs DEX regulations, user anonymity is different across the exchange platforms. When trading on centralized exchanges, users must provide detailed personal information such as name, social security number, address, and others. On decentralized exchanges, sensitive data is not required to complete an exchange.
Anonymity in decentralized exchanges offers an extra level of security for users, preventing any personal information from falling into the wrong hands.
Centralized and decentralized exchanges also differ in terms of trading options. As more regulated and experienced platforms, CEXes typically have more sophisticated service suites that allow users to take advantage of borrowing, futures trading, options, spot trading, leverages and more. DEXes, on the other hand, are mostly limited to lending, borrowing and exchange of crypto tokens that are based on the same blockchain.
Currently, the limited availability of trading options in decentralized exchanges discourages more experienced traders. However, DEXes are still in their infancy and it is highly likely that as they progress, more trading opportunities will arise. Already, the innovative use of smart contracts in DEXes, particularly in AMMs, has opened up new investment opportunities such as staking and liquidity mining.
Unlike centralized exchanges, DEXes are non-custodial and don’t require traders to entrust the exchange with their funds in order to complete a trade. Users remain in full control of their assets throughout the full transaction process thanks to smart contracts. Although this prevents certain risks, it’s also a cause for concern.
For example, the potential loss of private keys can lead to funds being irretrievable as the user has sole access. In a similar way, in the case of purchasing scam coins or sending digital funds to the wrong wallet, the transaction cannot be reversed.
One of the most difficult questions to answer in the CEX vs DEX debate is which one offers more security. On the one hand, centralized exchanges are considered more reliable as they facilitate crypto trading via sophisticated and centralized platforms. However, they’re also vulnerable and exposed to higher risks of cyber attacks. Developed exchanges are sometimes hosts to billions of dollars, making them a tempting target.
On the other hand, decentralized exchanges operate via smart contracts, which are code-based and extremely secure. However, the open-source nature of DEXes means that anyone can browse through the code, locate weak spots and take advantage by manipulating the system.
Transaction fees represent another important difference between CEXes and DEXes. Centralized exchanges are often a costly endeavour, as trades are regulated by central authorities. Making exchanges for large amounts can accumulate significant fees, making such exchanges less accessible for all. On the other hand, DEXes stand out with low transaction fees thanks to their reliance on self-executing, code-based algorithms.
When comparing CEX vs DEX in their current forms, user experience is also of great importance. Centralized exchanges certainly hold an advantage over DEXes in terms of convenience. They provide investors and traders with a user-friendly crypto trading solution, which in most cases is easy to understand even for beginners. Decentralized exchanges are still in their nascent phase and come with extra levels of complexity.
For instance, in order to participate in the exchange, users must connect a digital wallet like MetaMask to the platform. On a CEX, it’s enough to have an account to track your account balance and trade via apps and websites.
By conducting a CEX vs DEX comparison, we’ve come to the conclusion - that both centralized and decentralized exchanges offer certain benefits, but also come with their own challenges and concerns. For crypto exchanges to evolve to meet the expectations of the blockchain community, perhaps a creative merge between the two types of exchanges needs to emerge. As crypto trading becomes more popular, one thing is certain - we’re still to witness innovation and progress in both centralized and decentralized exchanges.
