Differences in DEX and CEX
What are the critical differences between central and self custody exchanges?
I like to think of Decentralized finance as the code that sits on top of Ethereum in the form of decentralized applications, aka dApps. dApps can be created by anyone and serve a ton of different purposes, including finance. DeFi is the combination of finance-related dApps. What is DeFi: In short, it’s the ability to either lend your Crypto and earn interest or borrow other Crypto for loans. Other dApps support the ecosystem like insurance and derivatives. DeFi is the wild west, and it’s important to know the risks before you enter the market. Here are some important differences between DeFi and a central exchange (CEX):
• Custody: Do you use a RobinHood, Coinbase, Kraken, or another trading account? These are centralized, meaning a third party holds your assets. If you decide to jump into DeFi, you will need to create a wallet. If you lose the password or give it to someone, there is no protection if your Crypto goes missing. No such thing as a helpline.
• No intermediaries: There is no actual intermediary in DeFi. We will review AMMs in a coming article to talk about how these liquidity pools work.
• Fees: This should be pointed out right away. Each time you make a transaction in DeFi, the protocol records the transaction on the blockchain. These fees are going to seem high as well. Rather than going through a CEX which spreads the fee across several transactions, you will be paying for it.
• Lending: Liquidity Pools Once you enter DeFi, you will want to earn interest on assets (that’s the whole point). You will need to lend your assets to Liquidity Pools. These pools are typically made up of two different tokens. You will need to get two tokens that match the pool- like ETH and LINK. These tokens need to be the same amount, like $50 and $50.
• Borrowing: Collateralization: Want to take a loan out? There is no such thing as credit history in DeFi. Each loan will need to be collateralized at least 75%. So let’s say you want to borrow $100 worth of ETH? You would need to lend another crypto of at least 75% to the pull.
• Rug pulls/ Hacks: REKKED. This is thrown around quite a bit, but it means you lose all your money. If one of these pools is hacked or disappears (called a rug pull), there is no way to retrieve your funds.
Okay, so now that you have a wallet and understand high level, let’s dive into a step-by-step guide on how to DeFi.
