The emergence of decentralized finance (DeFi) has led to something called a decentralized exchange (DEX) becoming popular. A DEX is in direct contrast to a centralized exchange (CEX).
They have many differences. This article will explain some of the key features between the two that make them different.
Key Features of DEXs
DEXs have a few key features that greatly separate them from a CEX. Here are some of those features.
First of all, a decentralized exchange has no know your customer (KYC) requirement. This means that a DEX is actually anonymous.
You can trade your cryptocurrency without anyone knowing that you have done so. It is important to note, however, that the coins in your wallet can be tracked using blockchain analysis.
In simple terms, if someone really wants to find you, then they can find you unless you take additional security measures to protect your identity.
Next, a DEX involves the use of non-custodial coins. This means that you always have control of the coins when you swap them.
It is quite different from a centralized exchange that is basically numbers on a screen until you withdraw the cryptocurrency to your wallet. Naturally, that withdrawal has potential issues because the exchange could not have enough liquidity to give you the cryptocurrency you request.
Remember, if you do not have the keys that control your cryptocurrency, then that cryptocurrency does not belong to you.
No Third Party Operator
The most important feature of a DEX is there is no single third party operator hence the ‘decentralized.’
This, in our opinion, is the single greatest benefit of a DEX. No third party operator means that no one can reject a transaction for any reason. The entire transaction process is automated as it runs on a series of smart contracts.
In fact, Satoshi Nakomoto would likely approve of DEXs. He envisioned a payment model that eliminated the need for a centralized middleman, which is what centralized exchanges have become at this point.
DEXs also typically have lower fees than a centralized exchange. However, this is not as significant on Ethereum as it sounds at first glance. Why is this the case?
Users must cover gas fees for the smart contract. This can be quite expensive on the Ethereum blockchain. In fact, it is way more expensive on the Ethereum blockchain than it is on a centralized exchange once gas fees are included.
Now, this is not a problem on a blockchain like Binance Smart Chain or a layer 2 Ethereum sidechain like Polygon. It is a problem on the Ethereum mainchain, which is where the majority of liquidity on a DEX is located.
Key Features of CEXs
CEXs get a bad reputation amongst the hardcore cryptocurrency community. However, they do have some features that make them much better to use than a DEX. This section will cover all the features of a CEX that differentiate it from a DEX.
First of all, a centralized exchange is not anonymous by any stretch. Every centralized exchange requires a user to submit Know Your Customer (KYC) information to prevent money laundering.
This information is also used by tax authorities to help them identify users that owe taxes on any cryptocurrency that they have sold.
In a way, this basically defeats the purpose of cryptocurrency because it removes the anonymity of it.
Controlled by a Central Organization
Another feature of a centralized exchange is that it is always controlled by a 3rd party. What does this mean?
It means that it is effectively the same as the banking system. The third party can deny customers for any reason, halt withdrawals, halt deposits, and everything else that a traditional bank can do.
At first glance, this sounds bad. What is the point of using cryptocurrency when it is controlled by a 3rd party organization?
Well, the answer to this question is covered in the next section.
Compatible With The Fiat Banking System
Centralized exchanges are compatible with the fiat banking system. For example, you can deposit funds from your bank account into Coinbase with two clicks.
This makes the process of going from fiat currency to cryptocurrency or cryptocurrency to fiat currency extremely easy. However, it does come with some risk as covered in the previous sections.
The compatibility a CEX has with the fiat banking system brings us to the final feature of CEXs.
Centralized Exchanges Are Easy To Use
The most critical feature of a centralized exchange is that they are extremely simple to use. Buying and selling cryptocurrency takes a few seconds on a centralized exchange. Fiat money can be transferred within a few days on and off of the exchange.
This is in contrast to a decentralized exchange. A decentralized exchange is not extremely difficult to use, but it is a little more difficult for those not fully used to how cryptocurrency works.
Which is better – DEX or CEX?
DEXs and CEXs both have their positives and negatives as we have covered. It is not really proper to say that one is ‘better’ than another one. A DEX is better for some people while a CEX is better for some people.
This section will cover which one is better for which group.
CEXs Are Best For…
Using a centralized exchange is best for people that want easy access to cryptocurrency and don’t have much technical experience. It is also good if you only plan on investing a small amount of money as centralized exchanges usually have less fees than a decentralized exchange. In bullet point format, the list would look something like this:
- Not technologically literate.
- Casual cryptocurrency investors.
- Do not care about privacy.
- Only interested in more popular cryptocurrencies.
- Selling cryptocurrency for fiat currency.
- This point is important because even the most hardcore cryptocurrency investors will likely end up ‘cashing out’ on a centralized exchange of some sort.
DEXs Are Best For…
On the other hand, a decentralized exchange is a completely different system. It is good for a different type of cryptocurrency investor. Typically, it is good for those much more serious about cryptocurrency with a moderate level of technological proficiency. Agan, the list would like something like this:
- Technologically literate – using a DEX is a little complicated.
- Cryptocurrency investors interested in newer altcoins.
- Users concerned with privacy.
- Users that want to get a better price – DEXs sometimes have better prices.
- Investors with a large amount of money because gas fees on Ethereum are higher than fees on a CEX.
Overall, DEXs and CEXs are not nearly as different as you probably think. A DEX has a clear advantage over a CEX because of privacy and decentralization.
CEXs have the advantage because they interface with the banking system and are generally easier to use. The drawback is that anonymity is completely lost due to KYC regulations. Outside of KYC, a CEX is actually an alright option if you do not leave your coins on the exchange.