Decentralized Exchanges (DEX) gained prominence in the wake of the hoopla around decentralized financial products (DeFi).
However, the rush to Uniswap’s decentralized exchange revived the discussion about the advantages and disadvantages of decentralized and centralized exchanges (CEX).
Numerous crypto enthusiasts feel that decentralized exchanges’ market share could considerably expand in the future. Additionally, many large cryptocurrency exchanges are presently developing a decentralized version of their trading platforms.
That alone is reason to examine the peculiarities of the various sorts of transactions. Will cryptocurrency trading truly decentralize in the future?
The History of Cryptocurrency Exchange Trading
Before we discuss the technical distinctions between CEX and DEX, let us take a look back in time. Indeed, the modern era of digital money and token trading is only a few years old. Much has changed since Satoshi Nakamoto mined the first bitcoin (BTC) block in early 2009 and sent the first transaction to Hal Finney.
In 2009, the New Liberty Standard established the price of one bitcoin as a central authority for the first time. Mt.Gox, the first Bitcoin exchange, opened its doors a year later. Mt.work Gox’s culminated in one of the most major robberies in cryptocurrency history in 2014. The exchange fell bankrupt after hackers stole 744,000 BTC.
Meanwhile, Coinbase gained fame and has grown to become one of the major cryptocurrency exchanges in the world. Coinbase, an American-controlled exchange, dominated the industry by offering a simple trading platform integrated with a wallet and a professional exchange.
Following that, and in response to growing interest in digital currencies, additional exchanges opened their doors.
The bulk of these exchanges were centralized, and well-known representatives such as Binance, Bitmax, Bitfinex, and OKEx swiftly rose to the top tier. For a lengthy period of time, these trade venues were unavoidable.
Only with the development of decentralized financial applications have decentralized exchanges such as Uniswap, Sushiswap, Compound, and Curve Finance gained prominence.
CEX vs. DEX — What are the differences?
As previously established, for many years, decentralized and centralized exchanges coexisted. Although DEXs did not achieve the popularity of their centralized equivalents for a lengthy period of time, they have played a significant role in the development of digital currencies.
Particularly amid the DeFi craze, DEX Uniswap even outperformed crypto behemoth Coinbase in terms of the daily trading volume. However, why are there two distinct sorts of transactions, and what are the distinctions?
Centralized Exchanges – CEX
Binance, CEX.io, Kraken, or OKEx are all examples of centralized exchanges that have their own order book. Each order is logged and approved in this section. To ensure data integrity, it is exchanged internally via dedicated servers and subjected to centralized security procedures.
CEXs are often regulated and have significant know-your-customer procedures built-in. Simultaneously, centralized exchanges vigorously pursue fraudsters in accordance with current regulations designed to combat money laundering.
Beginners, in particular, use this sort of exchange because the centralized structure enables a user-friendly platform that simplifies the process of purchasing and managing digital currency.
Orders and transactions are typically far larger in volume than on DEX. This is also because network nodes do not require real-time updates.
As a result, trade occurs at a breakneck pace. However, because of the platform’s simplicity, the private keys to the integrated wallets must remain on the exchange. Thus, access to crypto-assets is intrinsically linked to the user’s credentials.
If a fraudster obtains access to the credentials via phishing or a hack, they will have direct access to the crypto assets stored on the device.
A CEX is operated by a for-profit business. To ensure a positive user experience, these businesses frequently offer a broad range of support services. Additionally, they enable the purchase of cryptocurrencies using fiat cash and typically offer a diverse choice of trading pairs.
Centralized exchanges charge predetermined costs for trading. A crypto exchange, conceptually, operates similarly to any other exchange. Supply and demand are regulated by a matchmaking algorithm and the order book stores user orders.
Decentralized Exchanges – DEX
Additionally, a decentralized exchange performs the essential operations of a CEX. They consist of order books (or an Automated Market Maker (AMM)), a trading venue, a matching system, and security features.
The distinction between decentralized exchanges and centralized exchanges is that all of these functions are decentralized. To do this, a DEX does not utilize internal servers or its own IT infrastructure, but rather operates as a decentralized application (dApp) on a blockchain.
It is critical to distinguish between two types of decentralized exchanges in this context: currency-oriented DEXs and currency-neutral DEXs.
The former is frequently built on the Ethereum platform and utilizes Ether (ETH) as the primary medium of exchange. Additionally, other blockchains are feasible as an infrastructure foundation, but Ethereum commands by far the largest market share in this space.
As a result, the latter are not ecosystem-specific and are not reliant on the transfer currency. Atomic swaps enable the rapid exchange of coins that are distributed over multiple blockchains. The trade is governed by smart contracts, in which each party deposits the assets to be exchanged.
Users of decentralized exchanges like Uniswap, Bisq, or GDEX do so primarily for two reasons: anonymity and high security. DEX are anonymous since trading requires almost no user data.
Often, users are required to have simply a public address in order to trade on a decentralized exchange. As a decentralized program, there are no external parties (authorities or financial regulators) monitoring or regulating the exchange. Additionally, its success is due to its high level of security.
While CEX users lose control of their private keys, a DEX does not include an integrated hot wallet, and users retain control of their private keys.
DEX and CEX: pros and downsides
As previously stated, centralized and decentralized exchanges are fundamentally unlike. Due to this distinction, both forms of exchanges have distinct advantages and disadvantages.
In the following, we will discuss the distinctions between the two and emphasize the most salient good and negative characteristics.
Advantages of a DEX:
A decentralized exchange is not subject to government mandates, restrictions, or oversight. Users trade directly with one another, and no third party is engaged in the transaction. Each user has complete control over their private keys and thus their crypto assets.
Anonymity is undoubtedly a primary motivation for trading on a DEX. There is no authentication procedure, no Know Your Customer (KYC), and no uploading of personal papers to foreign servers. Typically, a personal address on the relevant blockchain is sufficient to begin trading. Between the exchange and authority, no personal data is exchanged.
Trading with a high number of trading pairs is often inexpensive due to the decentralized server network. This significantly reduces the possibility of a hacker attack and almost eliminates inaccessibility due to server faults. Because a DEX is hosted directly on the blockchain, it cannot be used to launch an assault against a central server.
Disadvantages of a DEX:
The disadvantages of a DEX include the fact that trading on a decentralized exchange is typically slower than on a centralized exchange. While this differs for each DEX, miners must validate each transaction. When it is important to react quickly to shifting market conditions, decentralized exchanges are ill-suited as a trading venue.
Liquidity is critical to an exchange’s performance. The most liquid exchanges are always among the most popular trading places. Due to the fact that decentralized exchanges are a relatively new concept, they have substantially fewer traders than CEX. Liquidity is also greatly reduced as a result.
DEX’s functionality remains limited. Additionally, the graphical user interface is frequently incomprehensible to newcomers. Many traders do not have access to limit orders, margin transactions, or stop losses. However, the majority of decentralized exchanges are exploring ways to incorporate CEX-like functionality.
Advantages of a CEX:
Even beginners may easily understand the user interfaces, and processes and procedures can be swiftly absorbed. Access to the respective trading alternatives is simple and straightforward. A generally high degree of functionality, with a diverse choice of trading options and cryptocurrencies.
CEX has a high level of liquidity as a result of its high trading volume. Payment responsibilities can be met swiftly and conveniently through the exchanges. The flurry of activity on centralized trading venues ensures that there are sufficient buy and sell orders to support market-friendly trading.
CEX is built on a centralized and distributed infrastructure. This permits near-real-time transaction interchange. Leading exchanges’ algorithms are capable of processing thousands of orders every second. Traders can react immediately to shifting market conditions.
The major mainstream exchanges offer a wide range of digital currencies with countless trading pairs. At the same time, deposits and withdrawals in fiat currency are also possible.
Disadvantages of CEX:
CEX’s disadvantages include the fact that users must store their crypto assets on the exchange. Because the integrated wallets are incorporated into the system, they are not within the user’s control.
Because the exchange owns the private keys, there is a risk of total loss if the exchange is compromised (Not your Keys, not your Coins). While cases of this nature are uncommon, they have occurred in the past, resulting in millions of dollars in losses.
Disadvantage debatable: centralized exchanges are subject to oversight by regulators, third-party suppliers, and legal authorities.
Operators are obligated to collect considerable data about their customers in order to combat money laundering (KYC). This regularity runs counter to the fundamental concept of cryptocurrency.
Summary: CEX vs. DEX – an unwinnable endless duel
The high level of interest in decentralized financial applications (DeFi) has resulted in a rush to establish decentralized exchanges (DEX). This sort of trading venue refers to an exchange that runs entirely on a blockchain and is not governed by a central authority.
DEX, as one of the most comprehensive forms of decentralized apps, enables traditional cryptocurrency trading. The advantage is that users can trade immediately without logging in and always have access to their private keys.
In comparison, centralized exchanges — abbreviated CEX — exist. A CEX (examples: Binance, Huobi, and Coinbase) is a decentralized exchange that operates its own infrastructure.
Unlike a DEX, a third party is always in control of trading activity. Centralized exchanges are attractive because of their high liquidity and rapid transaction processing. However, the user is constantly reliant on the exchange and has no access to his private keys in this situation.
As our overview above demonstrated, both types of exchanges have their benefits and drawbacks. The complete decentralization of a DEX is consistent with Satoshi Nakamoto’s fundamental concepts in the development of Bitcoin.
However, for many traders, CEX’s performance plainly argues in favor of using conventional exchanges. Many CEX, on the other hand, has recognized the benefits of decentralized exchanges and are already developing their own variations or incorporating DEX functionality into their systems.
As a result, future mergers of the two types at their respective interfaces are possible.