Ever since Bitcoin came along, it has promised an alternative way to deal with our finances. The alternative way offered by blockchain technology was called ‘decentralized’, and it meant that crypto users could get rid of the money-draining middleman and gain full control over their assets. This was a new and exciting perspective that inspired plenty of people.
Then, consequently, all kinds of cryptocurrencies and blockchains started popping up and things got a lot more complex as people wanted to exchange their cryptocurrency for various tokens, coins, fiat currencies, and vice-versa.
And that’s how the first cryptocurrency exchanges came to be.
CEX vs. DEX — What are the differences?
As mentioned earlier, decentralized exchanges and centralized exchanges have been operating in parallel for many years. Although the popularity of DEX has not reached the level of centralized peers for a long time, they occupy an important position in the history of digital currencies. Especially during the DeFi hype period, DEX Uniswap even managed to exceed the daily trading level of cryptocurrency giant Coinbase. But why are there two different types of exchanges in the first place, and what is the difference between them?
CEX — Centralized Exchanges
A centralized exchange is an exchange managed by a company. The company has a CEO and employees and has full control over the exchange. These are similar to traditional stock exchanges, except that they deal in cryptosystems instead of shares.
A centralized exchange, such as Binance, CEX.io, Kraken, or OKEx, has its own order book. In this, every order is recorded and validated. To ensure correctness, data is exchanged internally via dedicated servers and goes through centralized security processes. As a rule, CEXs operate under regulatory supervision and have extensive know-your-customer policies built in. Simultaneously, centralized exchanges actively crackdown on fraudsters following applicable laws to prevent money laundering. Beginners in particular use this type of exchange, as the centralized structure allows for a user-friendly platform that makes buying and managing digital currencies particularly easy.
The volume of orders and transactions is usually significantly higher than on DEX. This is also because the network nodes do not need to be updated in real-time. As a result, the trading speed is very high. However, the platform’s previously described simplicity requires that the private keys of the integrated wallets remain on the exchange. Access to crypto-assets is, therefore, directly related to the user’s credentials. Should a fraudster gain access to the credentials through phishing or a hack, they will have direct access to the stored crypto assets.
Behind a CEX is a for-profit company. To create a good user experience, these companies often offer a wide range of support services. They also allow the purchase of cryptocurrencies against fiat currency and usually feature an extensive range of trading pairs. Centralized exchanges have fixed fees, which are incurred when trading. Conceptually, a crypto exchange works on the same principle as any other exchange. A matchmaking algorithm regulates supply and demand, and the order book stores users’ orders.
DEX — Decentralized Exchange
A decentralized exchange is not directed by anyone. It has no CEO or employees. The exchange runs on blockchain technology and is sometimes controlled in a democratic way by which users participate in the exchange’s decision-making processes. Decentralized exchanges also do not depend on a third party to maintain the cryptocurrency so that it is faster to perform a transaction than in a centralized exchange.
A decentralized exchange also offers the core functions of a CEX. These include order books (or Automated Market Maker (AMM)), a trading venue, a matching system, and security functions. The difference to centralized exchanges is that all these functions are decentralized. To this end, a DEX is not based on internal servers and its own IT infrastructure but acts as a decentralized application (dApp) on a blockchain. Basically, it is important to distinguish between two types of decentralized exchanges here: currency-oriented and currency-neutral DEX.
The former is often based on the Ethereum platform and use Ether (ETH) as the central medium. Besides, other blockchains are also conceivable as an infrastructural basis, but Ethereum has by far the highest market share here. Therefore, the latter is not based on a specific ecosystem and are not dependent on the transfer currency. So-called atomic swaps enable a fast exchange of cryptocurrencies, which are located on different blockchains. The exchange is regulated using smart contracts, in which the parties involved each deposit the assets intended for exchange.
Users of decentralized exchanges use mainly due to two characteristics: anonymity and high security. DEX are anonymous because almost no user data is needed for trading. Often, users only need a public address to be allowed to trade on a decentralized exchange. There are no third parties (authorities or financial regulators) monitoring or imposing regulations on the exchange as a decentralized application. Another reason for its success is its high level of security. While CEX users have no control over their private keys, a DEX does not offer an integrated hot wallet, and the private keys remain in the possession of the users.
Now we figured out the basic concepts — what is DEX and CEX. Stay tuned, because in the next article we will talk about the advantages and disadvantages of DEX and CEX!
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