Find out the differences between Centralized Exchanges (CEXs) and Decentralized Exchanges (DEXs), how they work, and who they are best suited for.
Users typically enter the cryptocurrency world by buying and selling tokens on exchange platforms, which serve as gateways to digital assets. These platforms fall into two main categories: centralized exchanges (CEXs) and decentralized exchanges (DEXs). While both enable users to trade cryptocurrencies, they offer distinct features, advantages, and potential drawbacks. Understanding these differences is key to selecting the right platform for your trading needs and navigating the crypto landscape effectively.
Centralized Exchanges, or CEXs, are online platforms like Robinhood or Ndax used to buy and sell cryptocurrencies. These platforms act as intermediaries between buyers and sellers and provide an avenue to facilitate these exchanges securely.
CEXs use an order book system, a marketplace where users place buy and sell orders at a preferred price. In an order book, buy and sell orders are approved and logged internally when buyers and sellers meet at the same price. Simply put, the exchange executes the trade only where both buyers and sellers meet. If there is no demand, the order stays on the list until a request for the demanded amount is reached.
Because of the centralized nature of a CEX, users need to complete a KYC (Know Your Customer) profile. They need to be verified by providing personal details such as their ID, address, and proof of residency before going forward with their tasks. This is because CEXs need to comply with regulatory standards in their jurisdiction.
On CEXs, you can buy crypto with fiat currency (USD or CAD) and access many trading pairs. They are often more user-friendly and appeal to beginners due to their structured layout and customer support.
CEXs feature a variety of features that make them popular, especially for those new to crypto. A core characteristic of CEXs onboard so many new users is that they follow regulatory frameworks and process individual KYCs (know-your-customer). Users must disclose who they are by providing personal identification, which helps enhance platform compliance and facilitate card payments. Trading fees are part of how CEXs can sustain themselves and provide services. Fees are structured to pay for maker and taker fees and process withdrawals and transactions. Although many don't agree with paying fees, they help ensure transactions and trades can be done securely.
Customer support is a feature CEXs include to assist users in case of any issues. Unlike decentralized platforms, CEXs can help regarding account access, trading, limits, and much more. Such an addition is valuable for beginner traders who have not become used to complex platforms.
Advanced trading features are how trading platforms stand out from the competition. Margin or futures trading are ways CEXs create new ways of interacting with the market. With margins and futures trading, CEXs borrow funds to increase users' trading power. While this is appealing, it's only intended for experienced traders trying to predict future prices. The downside of using these features is that there can be little room for error, and assets can quickly get liquidated.
DEXs are decentralized exchanges like Uniswap that behave like a community marketplace. It allows users to trade directly from their wallet in a peer-to-peer manner. With that, they don't have to rely on banks or centralized entities like regulated exchanges to execute their trades.
DEXs are decentralized applications that run on the blockchain. Users must have a blockchain wallet on networks like Ethereum, Bitcoin, or other protocols that can deploy smart contracts.
On DEXs, trades are executed through smart contracts. These contracts are automatically enforced digital agreements that help execute actions without needing third parties. DEXs use Automated Market Makers (AMM) or Limit Order Books (LOB) without relying on centralized infrastructures. In the AMM model, traders are executed on pre-funded assets added to a liquidity pool. Then, prices are determined by a mathematical formula using Oracle networks to fetch real-time market data.
DEXs are a hunting ground for experienced traders. As DEXs are permissionless, emerging and new projects can create trading pairs and have their tokens listed as long as there is liquidity to back them up. This feature enables users to trade a broader range of assets, including niche tokens, which can appeal to traders looking to access new projects or less-known assets.
As DEXs are built directly on-chain, trade execution is facilitated by smart contracts, helping contribute to robust network security. Risks associated with centralized servers are easily mitigated, removing any uncertainty about potential hacks. DEX features focus on higher security through blockchain, but users should be aware of possible vulnerabilities in smart contracts. The fees paid for using the DEX can vary as the platform has a unique structure. It considers gas prices - to execute network transactions and slippage - which is the price impact when placing on-chain trade. As a result, using a DEX can lead to cost unpredictability, especially during times of high demand. As some traders have noted, when trading DeFi tokens, trading fees could reach as high as $200 per trade.
Finally, A DEX offers a secure, private, and independent trading experience for those who prefer to manage their funds without third-party intervention.
Let's take a closer look at the advantages and disadvantages of centralized exchanges.
Pros of CEXs
Cons of CEXs
Now, let's examine the advantages and disadvantages of decentralized exchanges.
Pros of DEXs
Cons of DEXs
As the crypto space continues evolving, the decision to use a CEX or a DEX depends on users' experience. We're seeing newcomers in the space to rely on CEXs because they are potentially trustworthy due to their higher security measures, are easier to onboard and have created a seamless user experience. A CEX provides the plug-and-play type methodology. Here, users don't have to worry about liquidity, layout, and fees - simply about trading.
On the other hand, DEXs give crypto natives additional control when interacting with digital assets. One of the main differences is fund custody, where individual wallets still hold all the assets. For most DEXs, UI is clunky, and platforms are launched as Beta. Even so, using DEXs requires previous industry knowledge of wallets, blockchain, and more. Using DEXs is a more complex system with additional assets they don't have, which can be costly.
Finally, both trading platforms have advantages and disadvantages, which should be considered depending on the type of user using them. CEXs might be the go-to platform for new crypto users since they KYC their users and provide access to crypto using fiat payments. DEXs are decentralized platforms that provide higher security, lower fees, and a custodial way of managing funds and remaining in control of one's assets. For those with some experience in the crypto space, DEXs are functional applications that help them explore additional blockchain features while projecting a certain level of risk when using them. In the end, it's up to the user to understand their needs, what their overall goal is.
Further Readings
Disclaimer: This article is not intended to provide investment, legal, accounting, tax or any other advice and should not be relied on in that or any other regard. The information contained herein is for information purposes only and is not to be construed as an offer or solicitation for the sale or purchase of cryptocurrencies or otherwise.