Cryptocurrency adoption has increased significantly over the past couple of years. Among all the other trends in the crypto space, trading has been the main focus of the industry. Cryptocurrency exchanges play a crucial role in the mass adoption of virtual currencies as they bring digital currencies closer to investors. Exchanges make it easier for investors and traders to interact with digital currencies while allowing them to make profits from the price fluctuations.
At present, two different types of exchanges – centralized exchanges (CEXs) and decentralized exchanges (DEXs) are available for Investors to trade cryptocurrencies. While centralized exchanges work more like online brokerage firms, decentralized exchanges take a different approach by including liquidity pools and automated market-making. Even though CEXs are more popular in the industry, based on a report published by Chainalysis, the number of DEXs between Q1 2019 to Q3 2021 has increased significantly by more than 100%. By solving major issues with centralized entities, DEXs are shaping the future of cryptocurrency trading.
In order to make a well-informed decision to choose between centralized and decentralized exchanges, traders need to be aware of the differences between them. This article focuses on the same and analyzes the pros and cons of using both of the exchanges.
Centralized Exchanges (CEXs)
Centralized crypto exchanges are very popular and have been around since the inception of cryptocurrencies. They allow users to trade cryptocurrencies by matching buyers and sellers through an order book. Since they work similar to traditional stock exchanges, they are more familiar to the investors. The centralized exchange takes custody of its users’ funds and monitors all the transactions that take place on the platform. Most CEXs are easy to use for beginners with less knowledge of cryptocurrencies and the technology behind them.
User-friendly: One of the most appealing qualities of CEXs is the user interface. Centralized exchanges make it simple for nascent crypto users who are unfamiliar with technical concepts. CEXs like Binance provide lite versions for users trying to make their first-ever basic trades.
High liquidity: CEXs operate under high liquidity which makes it easy for traders to exchange funds effortlessly at any time. As they provide high liquidity, traders can transact a large number of funds in a negligible time frame on centralized platforms.
Currency conversions: Crypto-to-fiat and fiat-to-crypto currency conversions are possible on CEXs as they allow users to connect their local bank accounts to withdraw and deposit fiat currencies. For example, US citizens can connect their bank accounts to a CEX and buy Bitcoin with US dollars.
Strict legal regulations: CEX is not a suitable option for traders who would like to keep their identity anonymous. Centralized exchanges are required to follow the KYC policies and ask their customers to confirm their identity by uploading legal documents.
The threat of hacks and breaches: Several instances have been witnessed in the community where CEXs were hacked and lost billions of dollars. As CEXs hold control of a large number of users’ funds, they become the primary targets for hackers. Due to the KYC policy, users provide extensive personal information, which raises the risk of leaking private data.
Custody of funds: Though CEXs provide ease of trading by providing high liquidity, they are “custodial,” which means they take custody of users’ funds. Going by the phrase “not your keys, not your coins,” centralized exchange wallets create a security risk for traders.
Examples of CEXs
Binance: Binance is the leading, beginner-friendly, centralized crypto exchange that charges the lowest transaction fees. It provides comprehensive charting options to assist traders. Users can avail various tokens listed on the Binance exchange.
Coinbase: Coinbase is also one of the popular CEXs that allows fiat transactions through PayPal. But it charges more fees and offers fewer tokens on the platform. Though Coinbase permits multiple ways to purchase cryptocurrency, it doesn’t provide advanced features to expert traders.
Kraken: Kraken is a feature-rich centralized crypto trading platform for crypto enthusiasts as well as large trading firms. A platform is a good option considering low fees and high security, but it has long verification times and a challenging user interface.
Decentralized Exchanges (DEXs)
Decentralized crypto exchanges are recently gaining more popularity by overcoming most of the issues faced by the users of centralized platforms. DEXs are autonomous financial protocols powered by smart contracts and eliminate the need for intermediaries. They involve advanced concepts like automated market-making and liquidity pools to make sure there is enough liquidity for traders. Traders do not need to rely on a third party to transact cryptocurrencies securely.
Privacy and anonymity: Decentralized exchanges do not request their users to follow KYC guidelines and submit all the private data. Traders just need to connect their wallets and sign a transaction in order to execute trades. No identity verification process is necessary while dealing with DEXs.
High security: DEXs are more secure compared to CEXs because they do not take control of users’ funds. As traders do not provide their private key information to DEXs, hackers cannot access the funds. Since there are no identity checks on DEXs, there is also no risk of leaking private financial information.
A wider selection of tokens: Decentralized platforms allow users to transact a wide variety of crypto tokens. It can also be possible to get access to newly distributed tokens through IPOs on DEXs long before the token is listed on a CEX.
Less user-friendly: Crypto trading on DEXs requires complex technical knowledge and is not suitable for most new users. DEXs also do not support fiat currency transactions which makes it difficult for users to buy digital assets with fiat currencies.
The efficiency of trades: Decentralized exchanges do not process trades as fast as centralized exchanges. The trading volume on DEXs is lower compared to CEXs. Because of lower volume and less liquidity, transactions take more time and high fees to be executed on DEXs.
Examples of DEXs
Pancakeswap: Pancakeswap is the most popular DEX built on Binance Smart Chain (BSC). It offers excellent trading features to the users by providing extremely low fees and faster transactions. The platform also offers secondary features and benefits like IFOs, lotteries, yield farming, syrup pools, etc to the CAKE holders.
Uniswap: Uniswap is an Ethereum-based DEX that allows users to swap ERC20 tokens on the platform. It is the leading automated market-making platform in the crypto community. Being one of the first successful DEXs, Uniswap lent features to most of the up-and-coming DEXs.
Pangolin: Pangolin is a community-driven DEX that runs on Avalanche and features a native PNG governance token on the platform. The platform is known for its quick and effective transactions because it allows users to make faster transactions for fees as low as a few cents.
BENQi: BENQi is a decentralized liquidity market protocol built on the Avalanche network. The platform allows users to lend, borrow, and earn interest from their digital asset holdings. By providing liquidity to the protocol, users can earn passive income through BENQi.
Differences between CEXs and DEXs
One of the major differences between centralized and decentralized exchanges is that CEX takes control of its users’ funds while DEX’s users retain control of their funds. DEXs are known to provide less liquidity for traders and take a long time to execute the transactions when compared to centralized platforms. While choosing a centralized platform, traders would have to lose control of their assets. On the other hand, decentralized exchanges may not provide as many features and benefits as centralized platforms. However, some of the new-age DEXs like Pangolin are solving the issues like less liquidity, high transaction fees, less speed of transactions by providing the best possible features to the traders.
As mentioned in the previous sections of this article, both exchanges have their own advantages and disadvantages. Choosing one of them depends on various factors like experience in crypto trading, knowledge of how to use them, the risk and fees they are willing to take, etc. However, considering the recent boom of decentralized finance and a huge increase in DEXs usage, they are likely to dominate the crypto trading space in the near future.
With recent innovations, developers are building efficient DEXs by overcoming all their past drawbacks compared to the CEXs. They now include features like high liquidity, low fees, faster transactions on DEXs while keeping them non-custodial and protecting users’ information. CEXs may have existed for a long time, but DEXs are more in circulation in present times.