Exchanges are the locations that you can use to buy or sell a cryptocurrency. Whether you are a newbie or a seasoned trader, you have various options. The majority of crypto trading takes place on these digital exchanges. Binance, Coinbase, Uniswap, and others are likely familiar names. The majority are centralized and operate on the same business model as traditional institutions. However, an increasing number of people are going decentralized and reconsidering how exchanges may work. The advantages and disadvantages of each type are discussed here. Over the last years, decentralized exchanges (DEXs) have emerged to challenge existing centralized exchanges (CEXs). In summary, DEXs attempt to reduce transaction fees, allow users to keep their assets directly, and bypass some regulatory restrictions. However, on the other hand, liquidity providers can suffer from a type of risk known as "impermanent loss" while providing liquidity in the pools.
CEXs have their own set of benefits. They typically provide better liquidity and regulatory safeguards, which are particularly crucial for institutional clients.
Centralized Exchanges (CEX)
Binance, Coinbase, Kraken, and Huobi are examples of centralized exchanges that have their own order book. Every order is logged and approved in this order book. Data is shared internally via dedicated servers and goes through centralized security protocols to assure accuracy. CEXs, for the most part, are regulated and have extensive know-your-customer regulations built in. Simultaneously, centralized exchanges vigorously pursue fraudsters in accordance with current regulations in order to prevent money laundering. Beginners prefer this type of exchanges because the centralized structure provides for a user-friendly interface that makes purchasing and managing digital currencies quite simple.
The volume of orders and transactions on DEX is typically much higher. This is also due to the fact that network nodes do not require real-time updates. As a result, trading pace is extremely fast. However, because of the platform's simplicity, the private keys of the integrated wallets must remain on the exchange. As a result, access to crypto assets is linked to the user's credentials. If a fraudster gets their hands on the credentials through phishing or a hack, they'll have immediate access to the crypto assets.
In CEXs, you can buy cryptocurrencies with fiat currency and usually have a large number of trading pairs. Fixed fees are incurred when trading on centralized exchanges. A crypto exchange, like any other exchange, operates on the same principles. Supply and demand are regulated by a matchmaking algorithm, and orders are stored in an order book.
Moreover, recently it was known that Sam Bankman Fried has been involved in many shady business ventures at FTX exchange. It turned out that FTX transferred $10 billion to Alameda, its sister company. Then Alameda used this transferred amount to involve in leveraged positions and basically placed risk bets. Once users got suspicious about FTX, they started to withdraw their cryptos from the exchange. Since the liquid assets at FTX were not covering all user funds, after some point, withdrawing assets were halted. Shortly after the announcement, more than 130 FTX Group Companies filed for Bankruptcy. Bankman-Fried vanished from the Bloomberg Billionaires Index overnight, with his net wealth plummeting 94% to nearly $991.5 million in a single day.
Decentralized Exchanges (DEX)
The essential capabilities of a CEX are likewise available on a decentralized exchange. Limit Order Book (LOB) model or Automated Market Maker (AMM) model can be used in decentralized exchanges. All functions are decentralized, as opposed to centralized exchanges. To this aim, a DEX operates as a decentralized application (dApp) on a blockchain rather than using internal servers and IT infrastructure.
Users of decentralized exchanges can benefit from two main benefits: anonymity and high security. DEX are anonymous since trading requires almost no user data. To trade on a decentralized exchange, users usually simply need a wallet. As a decentralized protocol, there are no third parties (authorities or financial regulators) monitoring or imposing regulations on the exchange. Its high level of security is another reason for its success. While CEX customers have no control over their private keys, DEXs do not have an integrated hot wallet, therefore users retain control of their private keys. It is your keys, your crypto.
Also Decentralized Exchanges can face some issues. For the liquidity providers, if the price of your deposited assets changes compared to when you deposited them, then you suffer from Impermanent Loss (IL). Impermanent loss happens no matter which direction the price changes. However, it is not realized until you withdraw your LPs from the pool. And it can be possible that through time, the ratio is restored, and you do not suffer from the IL - that’s why it is called impermanent. Moreover, there is also a slippage issue in the exchanges that use the Automated Market Maker (AMM) model. In this model, you never know the final price you will get at the end. However, in limit order book models, you know that your order will only be filled at the predefined price by you.
Summary of Key Differences
Decentralized financial applications (DeFi) have sparked a rush to decentralized exchanges because the crypto market grew significantly in the previous years. An exchange that works directly on a blockchain without a central controlling authority is referred to as this form of trading venue. DEX enables traditional cryptocurrency trading as one of the most extensive forms of decentralized apps. The benefit is that users can trade right away without logging in, and they always have access to their private keys.
Centralized exchanges, on the other hand, are abbreviated CEX. A CEX (examples: Binance, Coinbase, etc) is a cryptocurrency exchange that runs on its own infrastructure. In contrast to a DEX, the trading activity is always controlled by a third party. Centralized exchanges impress with high liquidity and quick transaction processing. In this case, however, the user is completely reliant on the exchange and has no access to his or her private keys.
Both types of exchanges have advantages and disadvantages as written in this article. However, despite CEXs offering various advantages, it is DEXs that truly reflect the core idea behind the crypto.
