DEX vs CEX —The Future of Crypto Exchanges
DEX (decentralized exchanges) vs CEX (centralized exchanges)
At the heart of the cryptocurrency movement and cryptoeconomic systems is decentralization; the idea that systems do not need to be centralized or ran from a single location. Decentralization is one of the many reasons that decentralized exchanges (DEXs) are so fascinating; after all, decentralized peer-to-peer transactions are one of the most secure ways to transfer cryptocurrency. However, decentralized exchanges never really took off in terms of popularity, and the point in time at which they’ll become widely adopted is still uncertain. At the end of the day, the success of decentralized exchanges will depend on how a number of factors play out. Let’s take a closer look.
What is a Decentralized Exchange?
A decentralized exchange, or, ‘DEX,’ can be thought of as a centralized exchange where all of the components of the exchange are decentralized. Users trade directly from peer-to-peer without working through a central authority; this is groundbreaking compared to traditional models of exchange (centralized exchanges) where an intermediary who facilitates the exchange is mandatory — in other words, a single entity operates the platform.
One reason that decentralized exchanges have the potential to disrupt the exchange space is because decentralized exchange users hold their own private keys — unlike centralized exchange users, whose funds and prevent keys are always in the hands of the exchange operators. That being said, centralized exchanges continue to be more popular than their decentralized counterparts.
The top five centralized exchanges (CEXs) by trading volume now control $2.8 billion in ERC20 tokens alone — about 26% of the total ERC20 market. And as customers continue to flow into these centralized exchanges, the ecosystem risks related to centralized exchange custody grows. CipherTrace estimates that in 2018, roughly $927 million in crypto was stolen — in the Coincheck hack alone $500 million was stolen. And unfortunately, even though the blockchain and cryptocurrency industry seems to be maturing, we are likely to continue seeing exchanges be the victims of hacks and breaches in the foreseeable future. Earlier this month ( May 2019), Binance — the cryptocurrency exchange that’s considered the most popular exchange by trading volume — was hacked for 7,000 BTC or about 42 million at the time of the theft.
What makes these exchanges prime targets for breaches, hacks, and theft is the fact that they pool all of their user’s funds into a centralized location called a “hot wallet,” a cryptocurrency wallet stored somewhere on the internet. An exchanges hot-wallet can be thought of as the exchanges centralized database; since the database is centralized, it only needs to be breached or hacked in that one location for every user’s information to get breached, hacked, or stolen.
And that is why decentralized exchanges are becoming an increasingly popular topic. On a decentralized exchange, users are in control of their own private keys; there is no central location that can be breached or hacked where a hacker can make off with every user’s personal information or funds. Instead, the exchange’s liquidity is decentralized, and all trades happen directly from one peer to another.
Decentralization Needs to Show it’s Advantages
The evolution of DEXs can shape the future of cryptoeconomics globally. Some even argue that decentralization is the “killer app” for crypto, however, this is only true if that decentralization improves performance compared to centralized alternatives — and if people are willing to adopt the decentralized product. Nonetheless, it is important to understand the various advantages that DEXs have over CEXs in order to see their future implications.
- Decentralized exchanges are more secure than their centralized counterparts which have a single point of failure and are therefore more vulnerable to hacks.
- Decentralized platforms are set up in a way which allows users to retain ownership of their coins using private keys; this results in a more customer-centric experience that gives users full ownership and control of their tokens. This means that a DEX users funds cannot be breached, hacked, or stolen unless that user is irresponsible with their private keys — a factor that they have control over and can prevent in most cases.
- DEXs allow a new kind of cryptoeconomics to take shape where new legal frameworks can spur growth, such as Malta’s radical and progressive DEX-friendly legislation.
Understanding the Limitations of CEX
Although decentralized exchanges hold a lot of promise for the future, and despite being in an era and industry of strong advocacy for decentralization, most crypto transactions still occur on centralized exchanges. As a result, most digital asset holdings are still vulnerable to hacks, market manipulation, fraud, abduction, and government-controlled user verification.
Centralization implies a center which means that a centralized entity can adjust fees and rates if they choose to; this makes it easier to implement a system where “the house wins.”
Centralized exchanges are also more vulnerable to being swayed by political, regulatory, and administrative decisions where crypto assets can be frozen, and they also run the risk of being shut down altogether.
In addition, the dominance of CEXs in the digital asset market means that bigger investors can dominate cryptoeconomics like they can any other investment where they own a majority of the shares in circulation or have better equipment and tools to trade with and analyze data — all the while, the average small-time crypto investor is put at a disadvantage. In other words, in some cases, centralized exchanges make it very difficult for the retail investor to “win.”
The Decentralized Exchanges of the Future
In order to create a fully decentralized exchange, the core components of the exchange must be decentralized; that means capital deposits, order books, order matching, and asset exchange must all be decentralized processes.
Decentralization and decentralized exchanges are likely to play a more significant role in our lives in the future than they do today. Currently, most of the world’s cryptocurrency trading is done through centralized exchanges such as Coinbase/GDax, Binance, Bittrex, etc., and most of the leading exchanges appear to be more interested in compliance and the creation of regulation in crypto than they are in investing in the future of DEX platforms (with some notable exceptions like Binance). For instance, in recent months, Coinbase, Gemini, Circle, and Kraken have all submitted or announced plans to apply for a brokerage license from the SEC.
Although regulation will indefinitely enter the blockchain and cryptocurrency spaces, the future of cryptoeconomics will also see the rise of better DEXs.
For instance, the Binance DEX has the potential to be one of the first decentralized exchanges that experiences a significant amount of user adoption. Binance is already a household name, and making the switch over to the Binance DEX is a seamless experience for most traders. Beyond that, Binance offers significant savings — 50% off trading fees — if you pay your trading fees in their native BNB token. For individuals who trade large amounts of crypto or find themselves trading cryptocurrency frequently, this discount can be a major incentive that gets them trading on the Binance DEX.
Regardless, we are in a transition from fiat and centralized exchanges to a more robust and widespread cryptoeconomic future. Therefore, the evolution of the decentralized exchanges is something we are watching very closely.
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