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Centralized Exchange (CEX) vs. Decentralized Exchange (DEX): All You Need To Know

Introduction

After the invention of money, the next step in human evolution was to learn about investment. The simplest form of living today is to acquire a skill and earn monthly income for adopting that skill as a profession. In this method of living, people save a little income aside from what is excessive for their usage. However, investors use their savings to create another mode of income for themselves. Investing on a national or international scale requires the presence of exchange markets such as DEX or CEX.

What is a CEX?

CEX is an abbreviation for Centralized Exchange. This is a type of exchange market that is under the control of a centralized regulator such as the government or Central Bank. In the cryptocurrency market, there are also centralized exchange platforms that allow users to trade cryptocurrencies on regulated platforms. Traditionally, stock markets and derivatives trading platforms are centralized to ensure the interests and safety of investors around the world. 

Origin of CEX

The first ever exchange market was established by the Dutch East India Company, which went public in 1611. This company issued stocks with a promise of issuing dividend income for the investors and laid the foundation for Amsterdam Stock Exchange. However, in the cryptocurrency sector, the first cryptocurrency exchanges were not compliant with any financial regulators.

After several failed early cryptocurrency exchanges, the biggest exchange platforms like Coinbase and Binance decided to become compliant with the regulatory agencies in their companies and around the world. The government of Germany was the first country in the world to grant a regulatory status to the cryptocurrency exchanges under its jurisdiction. 

How does a CEX Work?

A CEX allows the investors to create an account after following the AML anti-money laundering and KYC know your customer authentication. These methods are added as a security protocol for the users to make sure that they verify their identity using their national identification documents. With this option, it is impossible for anyone to create accounts under fake names and defraud other investors. At the same time, Centralized Cryptocurrency Exchanges can provide all the financial trading options such as buying, selling, borrowing, lending, and derivatives trading for the consumers. 

Types of CEXs

Stock Exchange

Stock Exchanges are the most common and oldest form of centralized exchanges. These exchanges have been around since the 17th century. There are thousands of stock exchanges in the world today with the most popular such as NYSE, Nikkie, London Stock Exchange, Shenzen Stock Exchange, NASDAQ, Six Swiss Exchange, Euronext, Bousra Kuwait, and others. Stock exchanges allow the companies to list their stocks on the market and allow the investors to acquire them for ownership and profit share. 

Derivatives Exchange

Derivatives exchanges are the platforms that allow investors to deal in stock derivatives such as options, ETFs, futures, swaps, and forwards. Derivatives are sales and purchase contracts that allow investors to trade stocks with a view of future price projections and time stamps. Derivatives exchanges are regulated by specialized centralized regulators. For example, the stock exchanges in the USA are under the supervision of the SEC; on the other hand, the derivatives exchanges are under the supervision of the Options Clearing Corporation (OCC) and Commodity and Futures Trading Commission (CFTC).

Cryptocurrency Exchange

Blockchains attempt to be as much decentralized as possible. However, there are many countries where the investors are complaining to the regulators about hacks, frauds, and Ponzi Schemes from unregulated DEXs. Therefore, more countries are making it mandatory for cryptocurrency exchanges to become compliant with the regulations and converting them into a regulated crypto exchange platform that is more secure for the users. 

Pros and Cons of CEX

It is important to take a look at both centralized cryptocurrency exchanges. With the proper knowledge about both sides of the coin, investors can understand the platform better. Here are some listed for the reference of the reader:

Advantages of CEXs

Centralized exchanges allow the users to make payments with a considerable amount of options. The users can attach their other cryptocurrency wallets, or make a payment using their Debit or Credit card. At the same time, it is also possible to use online trading merchants such as PayPal or Payoneer. Bank wires are also available.

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CEX has a simple and easy-to-understand user Interface to make sure that anyone hailing from any part of the world can navigate without any issues.

CEXs offer a greater level of financial security in comparison to decentralized exchanges. CEXs ensure that the withdrawals from the exchanges are limited and controlled. That is important for maintaining a healthy amount of capital for the stability of the organization.

CEX is available for users in the form of mobile applications. Users can create an account on the website and use the same account for trading from their mobile phones. CEXs are secure, and therefore they have a considerably larger number of investors, which increases the security. The amount of liquidity on CEXs is greater on account of the larger trading volume.

Disadvantages of CEXs

The gas fees on CEXs are usually higher since they are actively working to ensure the privacy and authenticity of users and transactions on the platform. It is not possible to place advance orders on CEX since they only allow the user to perform transactions only if they have verified their identity and account volume first.

Centralized exchanges need to regulate all trading activities happening on a network, which means that they only have a limited number of approved cryptocurrency exchanges listed on their platforms.

CEX often touts its customer services support network. However, in most cases, users with smaller investment accounts can’t get in touch with assistance from these platforms. 

What is DEX?

DEX is a short form for Decentralized Exchanges. The blockchain is intrinsically decentralized in most cases, and therefore most crypto users wish to trade them on DEXs. DeFi is a concept that allows users to perform financial transactions and other functions outside of the purview of a centralized financial network. 

It means that users can send and accept payment that does not have any restrictions or reporting obligations from a centralized government regulator. Decentralized exchanges are the type of cryptocurrency exchanges that enable the users to perform cryptocurrency trading without having any type of registration or approval and keeping their identification and transaction history secret.

Origin of DEX

The first ever cryptocurrency exchange was founded by a pseudonymous dwdollar. The codename dwdollar was a member of the Bitcointalk forum, one of the earliest Bitcoin forums in the world, where Satoshi Nakamoto was also a member. In January 2010, dwdollar posted about a new cryptocurrency exchange on Bitcointalk. Subsequently, after two months, the first-ever exchange called Bitcoinmarket.com went live. Bitcoinmarket.com was unable to keep up with the other cryptocurrency exchange markets and was dismantled shortly afterward. 

Types of DEXs

Automated Market Makers (AMM)

Automated Market Makers or AMMs make up most of the DEX platforms. AMMs allow the DEX to use a pricing algorithm for creating different liquidity pools on account of the book value of the cryptocurrencies. The main objective of AMMs is to keep the reserves in a DEX pool balanced at all times by allowing users to extract and add cryptocurrencies in a specified manner. There are no order books present in AMMs, which means that they are unable to cater to any complicated orders. 

AMMs also invite investors to pledge their cryptocurrencies to expand the liquidity pools and offer yield income in return. Some examples of AMMs are Pancake swap, Sushiswap, and Uniswap, among others. 

Orderbook-Based

Orderbook DEXs is one of the oldest forms of decentralized exchanges. Following the examples of the centralized cryptocurrency exchanges, these platforms used an order book. It was like a digital ledger that allowed all the users to list their proposed trade contract on the order book in advance. The other investors who were looking to complete the trade went through the order book to find the best match with their requirements. 

In the same way as AMMs, order books were also unable to carry out complex orders. It is worth noting that the process of ordering books was automated, but it was still relatively slower and more time-consuming. 

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Hybrid or Alternative

Hybrid or Alternative DEXs are the platforms that have taken some technological reference from both order books and AMMs to create a superior type of market. These platforms can eliminate some of the biggest limitations of AMMs, such as gas inflation, order congestion, and failed transactions. There are also platforms like Onomy Protocol that allow users to perform transactions across multiple blockchain networks. 

Pros and Cons of DEXs

Advantages of DEXs

DEXs are non-custodial platforms which means that cryptocurrency investors can keep their private keys with them individually. It also entails that the users do not have to hand over their private keys for making transactions on a DEX. On the flip side, users can connect their third-party cryptocurrency wallets with the DEX and conduct seamless trades.

DEXs charge a smaller amount of transaction fee from the users. This happens because the process of verification and authentication on a DEX is predominantly automated, and the cost of operating does not increase due to compliance with the financial regulators.

The protection of data and identification on a DEX is far better in comparison to the CEX. Users can create as many accounts as they want with any email address they have. Transactions speed is faster on a DEX in comparison to CEX since there is no waiting for getting approval or verification for account confirmation. 

Disadvantages of DEXs

DEXs suffer from smaller liquidity since the users prefer to be on CEX, keeping in view the greater financial security. DEXs do not have a lot of payment options available for users. The users can’t perform any transaction with fiat currencies on a DEX. However, they can perform transactions using stablecoins.

DEXs are largely in a state of under-construction. There are so many areas that the developers are working to improve and mend. Therefore, there can be some unprecedented delays on DEXs on account of the latest updates on the network.

Key Differences Between CEX and DEX

Now that the users have understood all types of DEX and CEX functions and classifications, it is best to conduct a comparative analysis. By comprehending the differences between Centralized and Decentralized Exchanges, the users can make the best investment decisions:

Accessibility

Accessibility is the quality of a computer program or a system that allows the users to utilize it at any given time. By design, the DEXs are more assessable for the users, which means that they are online 24/7. It happens since DEXs are automated, and they do not require the active supervision of any human or centralized enterprise to remain operational. On the other hand, the CEXs are only open for the users following the time set by the centralized regulatory authority. Typically, most centralized exchanges are only active during business hours. However, it is possible that the timing of the CEX can vary depending on the approval from the Centralized supervisors. 

Trading Options

Since DEXs are based on automated protocols like Automated Market Makers and Orderbooks, they are unable to deal with complicated orders. Therefore, the DEXs can’t incorporate the complicated modes of trading such as options, spot, futures, and others. The only available trading options provided by a DEX are crypto lending, borrowing, and speculative investment options. 

On the other hand, CEXs have all the options available in the same manner as other Centralized Trading Platforms, such as spot trading, Futures, and many more. CEX depend on semi-automated trading protocols; they have heavily sanctioned trading systems in place. They can only approve trading options for accredited and verified investors. Therefore, users can perform all types of complex cryptocurrency trading on these platforms, such as derivatives trading. 

Regulatory Compliance

DEXs inherently do not have any sort of compliance with any regulatory enterprise or government agency. They are automated platforms, and they are under the supervision of a private organization. However, since DEXs are usually non-custodial, it means that the users have full control over their cryptocurrency accounts. It also means that users do not have to complete any verification or authentication processes such as KYC or AML.

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On the other hand, CEXs are regulated, and they are bound to issue regular reports to the financial supervisors. It means that all the transaction data and the personal information of the users are shared with government organizations. On the other hand, it is also possible for the users to make sure that their users need to comply with authentication processes such as user ID and permanent address. A user can’t create multiple accounts under various IDS on CEX or keep their real identity a secret. 

Impairment Loss

The impairment loss is a phenomenon that results in the loss of the investment on account of the absence of liquidity on a platform. It means that users are unable to salvage their investment for the amount of their buy-in value. On a Centralized Exchange, there is more liquidity available on account of a greater trading volume and presence of users. Therefore, the probability of sustaining impairment losses for the investors on CEXs is comparatively smaller. 

On the other hand, DEXs are less secure and contain a larger percentage of investment and financial risks for the users. On the same note, the users on a DEX are mostly responsible for ensuring their safety while making trades due to greater financial freedom. Therefore, there are smaller numbers of users on a DEX that can, in turn, increase the possibility of impairment losses. 

Custodial Services

Most CEXs are a custodial platform which means that the private keys of the account are under the control of the management. This is done to ensure better security for the investors on the platform. However, users have lesser control over their accounts, and it can also result in a massive hack that can affect all the users on the platform at once. At the same time, all the cryptocurrency reserves present on a CEX are ultimately under the ownership of a centralized authority. In comparison, users on a DEX have full control over their reserves at all times. 

Decentralization

CEXs are not decentralized and are under the control and supervision of centralized authorities. At the same time, the DEXs are wholly or partially decentralized and community-owned projects. DEXs also incentivize the users to pledge their cryptocurrency reserves on the platform for increasing liquidity and earning yields. 

Liquidity

Since the trading volumes on CEXs are higher, it also means that there is a greater amount of liquidity on the platform. Meanwhile, typically the liquidity on DEXs is lower, citing the higher financial risks.

Conclusion

DEXs and CEXs are both useful cryptocurrency exchange platforms. They both carry some benefits and some limitations. Blockchain developers are continuously working to improve the protocols and ensure that these networks are useful for all cryptocurrency investors around the world. Investors who are aware of all the shortcomings and the advantages of the DEXs and CEXs can utilize them with better efficiency to make the best out of the available solutions.


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Hassan Mehmood (Saudi Arabia)

Hassan is currently working as a news reporter for Tokenhell. He is a professional content writer with 2 years of experience. He has a degree in journalism.

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