The digital assets exchanges market is booming. The CoinMarketCap alone lists more than 300 exchanges. Despite the bulk of them being centralized, times are changing.
The decentralized finance (DeFi) trend is reshaping today’s global economy. The very way of how we use money is being reimagined. Users can invest, lend and earn interest with their cryptos on platforms, governed by decentralized algorithms.
The above mentioned activities take place on decentralized exchanges (DEXs), which hold great future potential. DEXs gained popularity amid the buzz around DeFi products, while the rush to Uniswap, a decentralized exchange, revived the discussion about the benefits and drawbacks of decentralized versus centralized exchanges (CEXs).
Despite peaceful coexistence the decentralized trend is growing. Case in point — a recent development in the DEX space, where Uniswap outperformed one of the largest cryptocurrency exchanges, Coinbase in terms of daily trading volume.
The question, however, remains — how are these two types of exchanges differ from each other?
Centralized and decentralized exchanges are fundamentally different from one another. CEXs provide a user-friendly platform that facilitates the purchase and management of digital assets. They are governed by regulations and have rigorous know-your-customer (KYC) practices in place, in most cases. Due to the fact that network nodes do not need to be updated in real-time, the number of orders and transactions is often times much greater than those ones on a DEX.
A decentralized exchange, however, also offers core functionalities of a CEX. Order books, a trading venue, a matching mechanism, and security services are among them. Uniswap, SushiSwap, Bisq, and GDEX are great examples of decentralized exchanges. While aggregators, like 1inch allow users to find the best possible swap.
Since limited users’ data is required to execute a trade, DEXs are entirely anonymous. There are no third parties (authorities or financial regulators) monitoring or enforcing rules on the exchange, as it usually is the case on the centralized exchanges. On DEXs protocols reign supreme.
DEXs operate directly on the blockchain without a central governing authority. The decentralized protocol instills trust in the system and allows for the cryptocurrency trading to happen. The benefit is — users can trade immediately without logging in, retaining control over their private keys at all times. As for the fees, users have to pay the network to execute the trade. The drawback, however, is that the cryptocurrency swaps remain entirely anonymous.
When it comes to DEXs’ centralized counter parts, the likes of Binance, Huobi, and Kraken execute currency swaps within their own infrastructure. In contrast to a DEX, the trading activity is always controlled by a third party, which the user has to trust in order to execute the trade. Deep liquidity and quick transaction speeds are the reasons why centralized exchanges remain appealing to traders. The users are paying for the transaction, both on the maker and the taker side. This comes in addition to the network fee.
Despit the fact that CEXs have been quite successful in the past decade, with Coinbase making a public debut and Kraken mulling it over, the rise of decentralized exchanges cannot be understated. Month-on-month several tens of billions of dollars remain being locked in the decentralized protocols. Another important factor — more and more centralized exchanges are adding DEX-like functionalities to their ever-growing array of services. As a result, it is safe to assume that the we will see the merger of both types of exchanges into one. This could mean deeper liquidity, lower fees, less centralized governance and more freedom around what users can and cannot do with their cryptos.
flovtec is a Swiss technology company offering SaaS market-making (MM) solutions to digital asset exchanges & token issuers to enable liquidity. The company has developed fully automated market-making algorithms and connected to over 120 crypto exchanges providing liquidity to both liquid and illiquid tokens.
Connect with us:
Linkedin | Twitter | Anton Golub (CEO and Co-Founder) LinkedIn, Twitter
