Centralized (CEX) and Decentralized Exchanges (DEX)

Before we look at an overview of the difference between centralized and decentralized exchanges, it is important to understand crypto exchanges in general. They work similarly to the stock exchanges and brokers, but in the crypto sector.

As you are able to trade spot and future products in a traditional broker, and also lend and buy products that would give you earning, crypto exchanges allow you to perform the same actions with blockchain-based assets.

What Are Centralized Exchanges?

As the name implies, centralized exchanges (CEX) are crypto exchanges created by centralized organizations which exert control over ownership of the exchange, such as Gate.io. The centralized organization serves as the intermediary between buyers and sellers.

The most prominent highlight in the DEX vs CEX difference would focus on how centralized exchanges actually work as banks. You can deposit your crypto in the central wallet of the exchange, which stays in the control of the centralized organization. Centralized exchanges also facilitate documentation and execution of crypto trades on internal systems.

Centralized exchanges bring a wide array of benefits, including the ways in which they are suitable for crypto beginners. The user-friendly UIs and support of the centralized company behind CEXs offer the ease of recovering your crypto assets. In addition, centralized exchanges also provide the assurance of better liquidity with more users involved on centralized crypto exchange platforms.

On the other hand, centralized exchanges are not completely flawless in a CEX vs DEX debate, owing to their shortcomings. For example, centralized exchanges require KYC verification which violates the basic tenets of cryptocurrency, such as user anonymity. At the same time, centralized exchanges have all the deposited coins in the control of the company running the exchange. Therefore, crypto owners don’t have complete control over their assets on centralized exchanges.

Benefits of a Centralized Exchange

Centralized Exchanges are owned by an intermediary central organization, in the same way that traditional banks and brokers do. The main examples are Gate.io, Binance, Coinbase, Gemini, Crypto.com and Kraken. This type of structure presents some benefits, such as being or having:

• Custodial: A centralized exchange is custodial. Your funds are in a wallet, and this wallet is tied to the exchange - you only have to deal with your login, password and your account’s underlying security. If you’re a new user and are not much familiar with crypto and cybersecurity matters, this is the option that would suit you best.

• High Liquidity: These platforms have high liquidity and trades are made easy through the order book system, where buy and sell orders are automatically matched and executed. There is liquidity because CEXs offer incentives to liquidity providers (or market makers) - which are basically those users who provide liquidity in exchange for receiving trading fees.

• Friendly UX: Being usually the first contact of an investor with crypto, the platforms were designed to provide the easiest experience users could get.

• Compliant: From the moment an account is created, investors have to go through the KYC process, in order to comply with the security and anti-money laundering policies.

What Are Decentralized Exchanges?

Decentralized exchanges (DEX) are basically the counterparts of centralized exchanges, but with a different structure. Decentralized exchanges are free from the control of any single entity, serving as intermediaries. On the contrary, DEXs are actually smart contracts tailored for offering peer-to-peer transactions.

In a DEX, you don’t need any KYC verification for interacting with them, and in those exchanges there is a certain amount of user anonymity. The two notable categories of decentralized exchanges include order book DEXs and automated market makers (or AMM DEXs).

The first generation of decentralized exchanges followed the conventional order book model used in centralized exchanges. Some of the common examples of order book DEXs include the Gnosis Protocol or LoopRing. The order book DEXs rely on algorithms rather than central platforms for discovering and moving transactions among individual users. Smart contracts helped in documenting the transactions on order book DEXs.

Therefore, order book DEXs replaced the centralized organization with an algorithm and ensured decentralization. However, the order book model lacks in terms of efficiency, irrespective of the benefits of decentralization.

As a result, Automated Market Maker DEXs arrived on the scene for solving a notable issue with decentralized exchanges, i.e., liquidity.

Some of the common examples of Automated Market Maker or AMM DEXs include Compound, Uniswap, and SushiSwap. AMM DEXs is a significant highlight in CEX vs. DEX crypto exchange debates owing to their efficiency in replacing order books. Automated Market Maker relies on using liquidity pools sourced from users rather than waiting for matching buy and sell orders. People who invest their assets in the liquidity pool receive governance tokens which also ensure distributed governance in the exchange.

Benefits of a Decentralized Exchange

Since CEXs and DEXs main purposes are almost opposed to each other, the benefits of a Decentralized Exchange are:

• Self-custody: Users are in full control of their own funds and private keys, which eliminates the risk of funds being frozen or seized;

• More trading options: DEXs offer more trading options in terms of trading pairs and assets as they are not restricted by geography or regulations;

• No KYC: DEXs do not require users to go through the process of Know Your Customer (KYC) verification, which can be time-consuming and invasive.

• Greater accessibility: DEXs are accessible from anywhere in the globe and are not constrained by the same laws as centralized exchanges.

Conclusion

The two notable types of cryptocurrency exchanges, CEXs and DEXs, include the first generation platforms, which were more centralized in nature, and the recently emerging assortment of decentralized exchanges.

The type of exchange plays a crucial role in determining how a specific transaction works. At the same time, the features for the user and flexibility also differ considerably in the two types of exchanges.

The ideal exchange for investors depends on their goals: if they are interested in a UX-friendly platform and are insecure of being fully responsible for their own assets, a CEX is the best alternative. On the other hand, if more control and responsibility over their assets is a must, a DEX would be a better option.