Types of blockchain exchanges: DEX vs CEX
Crypto exchanges provide traders with access to buying and selling digital assets: coins, tokens, and stablecoins. Originally, it was only possible to trade on centralized platforms, but with the development of DeFi and blockchain platforms, decentralized trading platforms emerged and revolutionized the crypto industry.
In this article, you will learn what CEXes and DEXes are, what the differences between them are, and what their advantages and disadvantages are.
What is CEX (pronounced as “sex”)
A centralized Exchange (CEX) is an exchange operated by a company or group of people who make their own decisions.
Centralization means that users do not take part in the development of the platform, and all actions, in fact, are controlled by the leaders of the platform. This is the main disadvantage of centralized exchanges.
CEX exchanges are required to follow the rules of local regulators and obtain licenses to operate. For example, companies that are not registered in the United States cannot provide their services on the territory of this country and its residents.
For example, users who live or have a US residency cannot register and access an account on Binance exchange (which is centralized). But the company has a Binance US division that provides services to traders and the US.
Note: When we speak of advantages and disadvantages, we’re referring to large trading platforms. There are many illiquid and unlicensed crypto exchanges that often commit fraudulent acts towards their customers.
Companies (who provide custody services for the storage of assets) set limits, for example, on the amount of withdrawal of funds, or in case of errors. On the other hand, their clients are legally protected, but on the condition that the exchange has the appropriate licenses.
Crypto exchanges store no more than 5% of their own reserves in hot wallets. This means that in the event of theft, the damage to the company is small and it is able to quickly recover the losses at the expense of the reserve. Most of the company’s funds are kept in cold wallets, which can only be accessed physically, making it almost impossible to steal crypto assets from them. However, in the event of bankruptcy or the death of the founders who hold the private keys to the wallets, you risk losing all the funds.
Other advantages of CEXes:
- Large trading volume, high liquidity, low spreads and virtually no slippage.
- Users support.
- Low trading fees.
- Convenient and informative user interface that contains all the necessary information: quotes, charts, technical indicators.
- Support for various types of orders that make crypto trading more functional. For example, traders can set take profit and stop-loss orders.
The main stumbling block of centralized crypto exchanges is the lack of anonymity. Companies store user data on their servers, which can be leaked and transferred to third parties. Access to digital asset trading is often provided without identity verification (KYC), but users are required to complete it in order to carry out transactions with fiat currencies.
Another drawback is that the funds are kept in the accounts of the company, which can dispose of them without the knowledge of the users. Without any apparent reason, any user can find their account blocked. In other words, if you deposit money into the account of a centralized cryptocurrency exchange, you transfer it to the custody of a company, which can dispose of it at its discretion.
Traditional crypto exchanges are required to follow the requirements of financial regulators: provide data on customer transactions on-demand and block accounts in case of violations such as money laundering and other financial crimes. First, user accounts can be blocked by mistake. Second, it contradicts the very ideology underlying cryptocurrencies and runs counter to the principles of decentralization.
What is DEX (pronounced as “decks”)
A Decentralized Exchange or DEX is an exchange that operates autonomously and uses smart contracts that control the execution of transactions between users.
Traders can trade without intermediaries and use personal wallets that only they can access.
Note: An exchange on decentralized exchanges is called a swap.
DEXes are not controlled by any company or group, they do not store confidential user data and assets and do not apply restrictions to users when they’re making transactions.
One of the main advantages of DEXes is anonymity. Exchanges operate on the blockchain and do not impose any requirements for users, nor do they store personal information.
Decentralized crypto exchanges operate autonomously and do not depend on the requirements of regulators. No one but the community itself can stop the operations, but this does not mean that regulators cannot influence the process. For example, if the government introduces criminal prosecutions for trading cryptocurrencies, many users will stop using DEX exchanges and simply lose some of their liquidity.
Another plus is the large selection of digital assets. You can exchange any assets available on a specific network. For example, on the Uniswap exchange you can buy and sell ERC-20 tokens, and on PancakeSwap – BEP-20 assets. In addition, you do not need to wait until the token you are interested in is listed on the exchanges: trading is available immediately after the token is released on the blockchain.
Much like CEX, decentralized exchanges have disadvantages. The most dangerous of these is the lack of regulation. DEX exchanges provide their users with almost complete freedom, but at the same time, they remain legally unprotected: in the event of theft or hacking, no one guarantees the reimbursement of your assets.
Hackers can find vulnerabilities in the protocol code or backdoors in smart contracts, which allows them to withdraw funds. In this case, if the user’s assets are in the liquidity pools, then he loses them irretrievably. Even large blockchain platforms are regularly getting attacked: an anonymous user has stolen over $600 million from the Poly Network protocol. But this was an exceptional case, as the hacker voluntarily returned the stolen funds.
Let us look at another example. DEX platforms are known for allowing any user to issue their own token on them without restrictions. Cybercriminals take advantage of this by issuing garbage tokens. Investors who put their money in such tokens often lose it, and sometimes they lose a lot. In some cases, they even lose the entire amount invested.
For example, investors of the Squid token created during the hype around the Squid Game on Binance Smart Chain, witnessed it rise in price by several thousand percent, which has attracted the attention of users who wanted to get rich quickly. However, investors faced a problem during the sale: it was impossible to sell tokens on PancakeSwap, and soon the project’s website and social networks stopped working. The Squid project turned out to be a scam, and according to analysts’ estimates, users lost about $2.1 million.
In addition, criminals can freely use DEXes for money laundering, which causes other users to suffer. No one can freeze the attacker’s wallet, block or reverse the transaction. In some cases, law enforcement agencies manage to identify intruders, but most crypto theft crimes remain unsolved.
Finally, the choice of trading assets is limited to the blockchain on which the exchange operates. For example, you cannot exchange an ERC-20 Ethereum token for a BEP-20 Binance Coin token. But thanks to Wrapped Assets, you can use a blockchain bridge like the Binance Bridge to convert one blockchain token to another.
What is the difference between a DEX exchange and CEX one?
On average, the commission for buying and selling cryptocurrency on DEXes is 2 – 3 times higher than on centralized exchanges. In addition, users need to pay network fees per transaction. For example, on the Ethereum network, the cost of one transaction can exceed $100, and the average commission on the Uniswap exchange, according to Etherscan, at the time of this writing was ~ $68.
Ethereum network fees based on Etherscan’s numbers
Note: Ethereum is the first smart contract platform with legacy Proof-of-Work consensus technology. The Ethereum 2.0 update will solve the network scaling problem and increase bandwidth. In addition, there are better performing blockchains with lower transaction fees such as Solana, Cosmos, and Tron. For example, Osmosis DEX users (of the Cosmos network) can pay zero transaction fees.
Another disadvantage of decentralized exchanges compared to CEXes is low liquidity, which can lead to order slippage and large spreads during exchanges. However, in 2021, the largest cryptocurrency exchanges on the blockchain began to surpass even some large traditional trading platforms in terms of capitalization.
We have highlighted the properties of centralized and decentralized exchanges and presented them in a convenient table using which you can compare them.
|#||Centralized Exchange||Decentralized Exchange|
|Terms and Conditions||Only users who are 18 can register an account.||Any user can use a DEX by connecting a crypto wallet|
|Requirements||KYC/AMLPolicy. In some regions, users will not be able to access trading if they do not have the necessary licenses.||None.|
|Availability||CEXes are not available in all regions and for all users.||Available anywhere and to everyone, regardless of age, citizenship or any other factors.|
|Deposit and withdrawal||Free deposit of cryptocurrencies. When withdrawing from an account to a wallet, the network commission is taken into account. For the deposit and withdrawal of fiat, a commission is charged, determined by the company: usually it is 2% – 4% of the amount, but sometimes more.||Trading is carried out directly from the wallet.|
|Where the assets are stored||On the exchange account. Managers can use the assets.||In the wallets of the users themselves, who have complete control over their assets.|
|Privacy||Exchanges store confidential information about users. Although large cryptocurrency exchanges do not transfer data to third parties, except when requested by law enforcement agencies, the risk of information leakage that deanonymizes users remains. Unscrupulous companies can use private data for their own purposes.||DEX exchanges do not store private user data and do not use it in any way. You can use exchanges anonymously: this is the case when privacy is almost entirely dependent on the user himself.|
|In case of hacking||The exchange can compensate for the losses of customers at the expense of reserves.||The user is not protected. Exchanges do not guarantee the return of stolen funds.|
|Commissions||Crypto traders pay from 0.05% to 0.2% for the exchange. Exchanges generally do not charge fees for cryptocurrency deposits, and withdrawal fees are based on network fees per transaction on a particular blockchain.||Exchange fees range from 0.15% to 0.3%, which traders pay to liquidity providers. On top of this, you need to pay a network commission, which can exceed $50 on Ethereum, and sometimes $100.|
Which is better to choose: CEX or DEX? This question can only be answered by the users themselves, based on individual preferences, as each type of platform has its own advantages and disadvantages.
Centralized crypto exchanges pose a threat to the anonymity of users and can control customer accounts, but on the other hand, in case of theft, the company reimburses the lost funds of traders. DEX Exchanges are available to all users in any region, but they are not regulated and do not protect the users who are forced to bear all the risks.