A way to look at crypto exchanges in real life, regardless if they are centralized or decentralized, is to compare them to markets where everybody can make various trades.
In order for any economy to work properly, we need mediums that allow the transactions of goods, whether we’re talking about vegetables, clothing, or crypto, and we need an entity to mediate these exchanges.
Just like with a crypto exchange, when we go to a marketplace, everything works in pairs of two elements. Cabbage or cheese, as long as they have a certain value, we can purchase them using whatever is accepted in said market.
We can buy or sell vegetables and receive or pay in fruits, we can use the national currency, like most of us do, or any other kind of assets that are accepted by the involved parties.
When we talk about the digital world, but especially when we talk about crypto, things become, of course, more complex. Exchange platforms are essential to this economy since 1 Bitcoin wouldn’t have any value if we couldn’t sell it or buy it.
What Is A Centralized Exchange?
As mentioned before, exchanges are the main vehicles used for transacting digital assets. Centralized exchanges are online platforms that allow anybody to create an account in order to buy, sell, send, or receive crypto.
They are called centralized because transactions are always facilitated by a third party which means that the users of these platforms must trust that entity or the entities that operate them, just like with a bank, where, like it or not, we surrender the control of our assets.
The best known crypto exchanges of this type are Binance, Coinbase, Crypto.com, and FTX. They’ve reached this point thanks to several factors, the main one being the confidence people have in them.
Since these platforms take care of the security of the assets of every user, this aspect is very important when it comes to choosing the platform on which you are transacting.
It is worth mentioning that these exchanges offer, basically, a digital medium as order books in which users can place orders to sell or buy any pair of available assets on the platform.
What Is A Decentralized Exchange?
On the opposite end, decentralized exchanges are platforms where users can make transactions without the need of a third party acting as intermediary, and the funds remain under the control of the user. This is one of the main reasons why these types of platforms were created.
The need to trust an intermediary when we make transactions on a centralized exchange lead to the creation of protocols that work automatically, without a KYC, and, most importantly, without having control over the assets.
How do these platforms work? Through a network of smart contracts, or to make it simpler, a set of algorithms, that allow users to transact directly from their own wallet. Since liquidity is added also by the users, there is no need for intermediaries to facilitate the transactions.
The best-known decentralized exchanges are Uniswap, Sushiswap, and Curve, all on Ethereum.
DEXs and CEXs have their pros and cons.
CEX vs DEX
CEX advantages:
– Easy to use
– Safe and, in most cases, willing to return funds in case of a hack
– Allow the introduction of fiat into the world of crypto
– Orderbook trading
– Multiple features
– Are recognized by institutions
– High trading volume
DEX advantages:
– Transacting directly from your own wallet
– Anonymity
– Access to many coins
– You don’t lose the control of your assets
CEX disadvantages:
– The assets are controlled by the platform
– You have to go through the KYC process
– Hacks
– Limited access to new coins
DEX disadvantages:
– More complex to use than CEXs
– Vulnerabilities in the smart contract network
– Don’t allow the transaction of fiat / crypto
Conclusions
Both DEXs and CEXs are fundamental in the evolution of this industry because it’s important to have diverse options. This increases the level of competition which, in turns, makes the platforms strive to do better and be more efficient.
CEXs currently attract about 95% of the crypto trading which tells us that DEXs still have things to work on in order to attract a higher market share.