Differences Between DEX and Centralized Exchanges
By Ihor Shulhach 3387 29 Sept 2022
Today there are two types of exchanges - centralized and decentralized in the crypto industry. Let’s find out the differences and advantages of DEX and CEX.
CEX - centralized exchange. Transactions on CEX require the presence of a third-side party during them. Exchanges have a centralized server where all assets are stored. The user needs to pass the KYC process and pay commissions in order to sell or buy cryptocurrency.
WhiteBit crypto exchange is an example of a centralized exchange. It provides the opportunity to trade and exchange crypto assets, fiat currencies and also ensures the security of transactions and the safety of user funds.
DEX - decentralized exchange that provides a platform for the counterparties' interaction: to buy or sell cryptocurrencies. At the same time, the exchange itself does not act as a direct intermediary in the exchange. Such platforms are regulated exclusively by blockchain mechanisms. It allows two parties to be engaged in peer-to-peer transactions for a minimal fee. However, both parties remain completely anonymous and can exchange assets with zero trust in each other.
Uniswap is an example of a DEX. This exchange uses a financial protocol that speeds up the exchange of cryptocurrencies on the Ethereum blockchain. It uses an algorithm that collects liquidity pools information relating to the current dynamics of supply and demand between given tokens.
Main differences between CEX and DEX
Centralization: CEX has the infrastructure and a high level of control to ensure the accuracy and efficiency of every transaction. This is achieved by centralizing processes and scanning data through internal servers.
At the same time, DEX allows users to interact with the blockchain directly. Traders are in full control of their assets.
Control over funds: in the case of CEX exchanges, it is understood that users “give” control of their assets to a centralized server, which provides storage and access to various useful functionality (trading terminal, staking, promotions, etc.).
On DEX exchanges users make their own rules by using smart contract technology.
Security: The disadvantage of CEX is the possibility of hacker attacks on the central server, which can damage the entire system. However, CEX security infrastructure is better protected from fraudulent schemes than DEX.
As for DEX, a hacker will not be able to attack the central system, since it does not exist in principle. Attackers can extract tokens from liquidity pools due to the vulnerabilities at the smart contract level. And DEX complete anonymity increases the risks of money laundering.
Liquidity and Speed: Liquidity is a measurement of how easily one asset can be converted into another without affecting its market price.
In the case of CEX, high liquidity is ensured by a large volume of orders, as well as by the fact that the infrastructure of the exchange works outside the blockchain (exchange transactions are carried out at the level of exchange wallets without any delay to validate the network itself).
DEX liquidity may not be sufficient. This is due to the use of the order book and AMMs (automated market makers). The flow of exchange transactions is always different and blockchain transactions undergo a confirmation procedure (different blockchain provides different speed).
Control and Censorship: A centralized exchange usually asks for the personal data of its users. KYC reduces the risk of fraud, but the exchange can freeze the user's accounts, deny service or apply any restrictions at any time. As an example we can recall that Coinbase blocked accounts of Russians due to the sanctions.
DEX lacks that level of control because there is no central authority that can block anyone from participating in the blockchain. Traders are completely anonymous and all trades are made without requests for personal information.
Fiat currency: CEX provides the ability to buy and sell fiat currencies, DEX offers crypto swaps only.
What to choose: CEX or DEX?
CEX provides simple trading mechanisms, however, you need to accept non-trading risks in the form of transferring your own funds to a third party (exchange). CEX has all the benefits of fast and liquid trading. You can both exchange cryptocurrencies for fiat and trade cryptocurrency pairs. This is a convenient and easy way, but CEX usually charges a fee for this, small as it may be, but still it’s a fee. In addition, there is the risk of hacker attacks on the exchange server.
DEX leaves full control over the funds to the user. There is no single place to store assets and there is no data to hack. The user is also guaranteed complete anonymity. With the development of the blockchain, parameters such as speed and liquidity are gradually improving. But there is still the danger of smart contracts being vulnerable, as well as the lack of proper regulation.