Differences Between Centralized Exchanges (CEX) and Decentralized Exchanges (DEX)
People are starting to explore the world of crypto, with interest in Bitcoin or Ethereum. The easiest way to do this is via large exchanges such as Coinbase or Binance. But as they continue to explore the world, they stumble upon exchanges such as Uniswap.
They start to do a bit of research and discover that some say Uniswap and the like are more in line with crypto ideals. Others say that Coinbase and other similar exchanges have more to trade and are more user friendly.
So what do decentralized exchanges like Uniswap have that centralized exchanges like Coinbase don’t?
We’ll explain the fundamental differences between centralized (CEX) and decentralized (DEX) exchanges to clear up the obscurity.
What is a Centralized Exchange in Crypto?
CEX is an exchange where there’s a middleman who conducts and oversees trades and handles the assets. Whenever you exchange one coin for another on a centralized exchange, the transfer isn’t directly between you and the other person. Instead, the exchange manages the trade.
Imagine you’re living in a village where people don’t use money but trade goods. If you’re growing potatoes, you might want to give some potatoes to the cow farmer for milk.
One day, a group of villagers creates a market in the village square. The governed market works 24/7 and allows for a more organized exchange of goods, creates safety, and you no longer have to worry about not exchanging your potatoes. The villagers who created the market also own the market. Meaning, they make a profit from each trade people make.
You give potatoes to the market and take milk. Once the cow farmer needs potatoes, they go to the market to trade.
But keep in mind that, in the crypto world, you don’t get to take your potatoes and milk, aka crypto assets, home and store them in a personal safe. Instead, although you own them, they stay in the market in a safe with your name on it. But we’ll come back to this crucial aspect later.
What is a Decentralized Exchange in Crypto?
A DEX is a type of exchange where there’s no third party. In a DEX, you hold your assets instead of entrusting them to a third party like a bank.
Let’s go back to our village. There isn’t a centralized market in the village square controlled by a specific group. Instead, the villagers create a huge automated safe that nobody governs. You can only take from the safe as much as you give, depending on the current potato/milk prices.
So whenever you need a specific good, you go to the enormous safe, do the transfer, take the goods back home, and store them in your personal safe.
Differences Between DEX and CEX
Now that we have a better idea of a centralized and decentralized exchange, let’s dig deeper into critical differences, advantages, and disadvantages.
Crypto Asset Diversity
There are more than 4,000 different cryptocurrencies in the market as of 2021.
To get on a CEX, an asset needs to satisfy security protocols, have trading activity, and comply with legal standards.
On a DEX, you can list anything. This means more risk, but it also means you might trade new, highly-demanded assets. Everybody has milk and potatoes, but that mango might grow in price soon. Make sure you do your research or you’ll end up with a bag of rotten assets.
Security & Privacy
In a CEX, you’re less likely to come across a scam. Meaning, it’s not probable that you’ll exchange potatoes for milk, go home, and realize that it’s water instead of milk. People buy unknown coins and lose their entire investment because the project ends up being fake, and scammers run away with millions worth of crypto assets.
Similarly, your personal safe, aka wallet, is in the centralized exchange’s hands. This means if you forget your wallet’s password, you can ask the exchange to reset your password.
In the DEX world, if you get scammed, there’s no way to rectify it. Also, since you own your wallet, if you forget your password and your seed phrase (a set of random words that only you know), you can’t reset the password.
But imagine one day, the police arrive at your village and deem the centralized market exchange illegal. Or a group of robbers (hackers) breaks into the market. Remember those goods you need to keep in the personal safe inside the market exchange? Everything is gone. But your neighbor who’s been trading on a DEX keeps all of his assets even if the DEX shuts down.
Technological Maturity
CEXs are like any other large service on the Internet such as Facebook, Twitter, etc. They use established technology that’s more stable and has far fewer hiccups and bumps for the end-user.
One major flaw regarding DEX technology is scalability. A blockchain network depends on the transaction load it can handle before reaching its limit. For instance, as of May 2021, Ethereum handles 30 transactions per second. Card giants such as Visa handle around 1,700 transactions per second (although Visa claims it can handle 24,000 transactions).
Fortunately, blockchain is a rapidly evolving technology, so the limits DEXs are facing are bound to get less significant in the near future.
Bottom Line
While a centralized exchange is more user-friendly and theoretically safer, a decentralized exchange is a new technology that will likely become the standard in the future.
But if you’re trading bitcoin and other crypto assets, you’re thinking more of making money today or tomorrow than what will happen in 10 years.
CEXs are a safe introduction to the world of crypto trading in terms of short-term benefits while DEXs are a riskier place where you can get higher rewards if you play the game right.
The bottom line is to do both. And remember the golden rule of crypto trading; never invest something you’re not ready to lose. Otherwise, you’ll end up without the potatoes you worked so hard to grow and with a sack of spoiled milk and rotten cryptos.
Arianee recently listed on a DEX, after being traded on Uniswap for some time. For our in-depth article on why we chose to trade on a DEX, specifically Bittrex, jump over to our article on that HERE.
