Decentralized Exchanges (DEX) are rising in popularity among crypto-savvy investors. These are the reasons why they choose DEX over Centralized Exchanges (CEX).
Centralized exchanges are governed and controlled by a single authority. DEX platforms like Uniswap are community-driven decentralized platforms that run on codes.
DEXs have gained substantial popularity mainly because it is a decentralized platform, user-friendly, and gives full authority to their users.
One of the fundamentals of DEX is that they provide complete privacy. Unlike CEX, users do not have to go through any KYC verification or documentation which provides full anonymity to their identity.
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The rise of crypto exchanges came into prominence over the past few years. The decentralized finance (DeFi) market is largely ruled by these exchanges and has made it possible for millions of buyers and sellers to trade across the globe.
What is a Crypto Exchange?
Just like a stock exchange where investors buy and sell stocks and bonds, a crypto exchange allows its users to buy, sell, and trade cryptocurrencies. Crypto exchanges consist of two types – centralized exchanges (CEX) and decentralized exchanges (DEX).
Centralized exchanges like Binance and Kraken are governed and controlled by a single authority. All powers are vested in this single entity. DEX platforms like Uniswap are community-driven decentralized platforms that run on codes. They are not owned by any centralized authority.
CEX and DEX are the two gateways to the DeFi market. A crypto trader can either participate in a CEX platform or a DEX platform. Though both platforms have their own possibilities and drawbacks, the DEX platform has some integral qualities and owned significant importance over the years.
What are Centralized Exchanges (CEXs)?
CEXs are the first generation of crypto exchanges. They operate on the same business model as our traditional stock exchange markets. Some examples of CEX platforms are Binance, Gemini, Coinbase, etc.
In simple words, “centralization” means that all crypto transactions are conducted with the help of middlemen or third parties. All transactions are done in exchange for fees.
The centralized exchanges maintain an order book where all transactions are validated and recorded. All data and user information are stored in exchange servers. The CEX platforms collect the personal data and bank details of the users. Users have to follow KYC verification and AML guidelines to prevent money laundering practices.
What are Decentralized Exchanges (DEXs)?
Decentralized or DEX platforms were built to overcome the shortcomings of centralized exchanges. DEXs are blockchain-based crypto exchanges that run on automated algorithms and eliminate the conventional barriers of financial intermediaries.
These automated algorithms are known as smart contracts or codes written on the blockchain network. Smart contracts can run thousands of transactions. Buyers and sellers can directly participate in business without paying any fees to the middlemen or brokers.
DEX is a peer-to-peer (P2P) market exchange built on open-source codes where all transactions are performed directly on the blockchain network. To facilitate transactions, investors lock their funds in liquidity pools and in return earn rewards.
DEX platforms are normally non-custodial where users have full control over their wallets and assets. Furthermore, the innovation of the AMMs (automated market makers) solved the liquidity problem of the DEX exchange platforms.
Pros & Cons of DEX
DEXs have gained substantial popularity mainly because it is a decentralized platform and gives full authority to its users. Let us now see some of its benefits and drawbacks.
Anonymity – One of the prime reasons why many crypto traders prefer DEXs is because of their anonymity and privacy. DEX does not require you to share your personal details or private key information with your wallets. There is no need for any KYC verification.
Non-custodial – Unlike CEX, DEX is completely non-custodial which means you are in control of your funds and wallets. You just need to link your wallet to the DEX platform and complete the transaction.
Governance protocol – DEX operates on distributed governance protocol. It democratizes the platform and vests power on the participants. Users have the right to take important decisions and earn rewards for providing liquidity.
Token accessibility – In centralized exchanges, you get access to a limited number of listed tokens that have been authorized by the local regulations. In decentralized exchanges, there are no such regulations and users can find many new projects that have not yet been listed on the CEX platforms.
Reduced third-party risks – In DEX, all transactions are based on a peer-to-peer model and do not involve any third-party involvement. Since all transactions are based on smart contracts, users can audit and verify these contracts and eliminate counter-party risks.
Requires specialized knowledge – Navigating DEX platforms requires substantial knowledge and analysis. The interface may be slightly complicated for new investors. Users have to make important decisions such as selecting a wallet that the network supports and also funding the wallet with the native token of the network.
No fiat support – Unlike CEX, DEX does not support payment in fiat currencies which can be a potential drawback for newcomers.
Limited liquidity – This has always been a major issue for DEX platforms. The transaction volumes are also much higher in CEX.
High fees – CEX requires a brokerage or a trading fee. Since DEX runs on a blockchain network, trading may be expensive as users have to pay a transaction fee along with gas fees.
Risky tokens – Anyone can list a token in a decentralized exchange. Often these tokens are not vetted properly and may be susceptible to huge scams.
"Because custodially held crypto assets may be considered to be the property of a bankruptcy estate, in the event of a bankruptcy, the crypto assets we hold in custody on behalf of our customers could be subject to bankruptcy proceedings and such customers could be treated as our general unsecured creditors," - Coinbase
Decentralized exchanges are continuously evolving bridging gaps to provide better security. Cryptocurrencies have revolutionized decentralized finance removing the dependency on a centralized institution. Transactions are done on a transparent ledger system and have limited government interference.
Now that you have a complete understanding, tell us what would you prefer - CEX or DEX?