There is a very well-known saying made famous during the California gold rush: “During a gold rush, promote shovels.” This phrase indicated that there are more innovative methods to capitalize on a rising enterprise without immediately competing with the alternative gold miners.
Since the crypto bull market in 2017, many innovators in the crypto industry have recognized that not competing, but rather providing something different, is one of the maximum surefire methods to capitalize on the rising crypto asset class.
Fast forward to 2021, and many exchanges have failed; however, people who made it through the bear market have emerged as leaders in the crypto world, far surpassing their traditional finance competitors in both wealth and innovation.
The concept of exchange has evolved and those in DeFi now operate as entirely decentralized platforms with no centralized authority or governance, run by smart contracts and referred to as Decentralized Exchanges (DEX).
Facilitating understanding of the differences between Centralized Exchanges (CEXs) and Decentralized Exchanges (DEXs) is an essential first step that newcomers to the crypto market must take. The following is a breakdown of the distinctions between CEX and DEX that need to be understood to properly invest in alternative forms of finance such as crypto.
What is a Centralized Exchange? (CEX)
A CEX is a platform where you can buy and sell digital currencies called cryptocurrencies, and its infrastructure is taken from traditional finance (TradFi) much like the New York Stock Exchange (NYSE). With centralized management and private infrastructure, CEX platforms have full control over how supply and demand are regulated.
Compliance with TradFi regulations and traditional business practices are upheld and customers experience less autonomy in how their crypto assets are traded. Examples of established CEXs include Coinbase, Binance, FTX, and many more.
What is a Decentralized Exchange? (DEX)
A DEX is a platform that runs on a completely decentralized and open infrastructure and facilitates the exchange of crypto assets by anyone, anywhere, at any time, without the need for identification or authorization from a governing body.
The concept of a DEX has slowly developed since 2017 with the most recent innovation of the Automated Market Makers (AMM) algorithm popularising DEX and lending to mass adoption of these platforms. DEX’s are powered by smart contract technology that is open-sourced, transparent, and with code that can be audited by anyone.
This transparency and open access results in accountability of trading volume and sources. Examples of established DEXs include Uniswap, Sushiswap, and SERUM.
Distinctions of CEXs
The following outlines the distinctions between CEX and DEX, with efforts to distinguish the pros and cons of each. CEX is an accessible option for users due to its familiarity with traditional financial platforms, whereas DEX pushes people out of their comfort zone with its innovative technology and decentralized infrastructure.
CEXs are arguably more user-friendly at this point in time due to their convenient design and reliable centralized structure, catering to retail and institutional investors alike who rely heavily on customer support and services which align with their traditional customer experience.
Large corporations, old family offices, and global retail outlets find comfort in the privacy that CEX platforms afford their transactions, placing trust in the central figures governing the online trading, and finding solace in the separation from the public having access to their financial records.
CEX platforms provide users with cross-chain support which translates into crypto assets being easily accessible across multiple blockchain networks with options for withdrawals and trading that don’t require additional fees, unlike DEX platforms that require users to use a bridge for cross-chain trading.
CEX trading fees are stable meaning users will not be affected by rising gas fees during times of high network usage, unlike DEX trading fees which spike dramatically when networks become congested.
As previously mentioned CEX complies with traditional regulations and will for the foreseeable future which is an attractive drawcard for traditional investors such as family offices and institutional investors who wish to gain capital and be protected from volatility.
CEX offers trading features that mirror those of traditional financial institutions including trade features such as limit orders, trailing stop losses, and more, whereas the majority of DEX’s do not currently offer these complex trading options to their users.
Distinctions of DEXs
Ability to self-custody
The control of digital assets rests entirely with the users on DEX platforms, meaning that custody and control remain in the hands of the customer. This eliminates counterparty risk, including if an exchange runs away with customers’ funds, or the exchange is hacked.
Users of DEX platforms can remain anonymous as there is usually no mandatory KYC for these platforms.
With no central authority governing the DEX platforms, users can become token holders to have a say in the future of the platform. Decentralized Autonomous Organizations (DAO) enable token holders from DEX platforms to have a say in which direction they think the platform should take.
A definite pro for users of DEX is their ability to trade all kinds of cryptocurrencies that are otherwise not available on certain CEXs. Projects can also bootstrap their tokens liquidity to become accessible to traders without needing to apply for their tokens to be listed on a CEX.
Market participants and liquidity providers on DEX platforms are promised higher yields and incentive programs with their investments. These incentives currently exist for liquidity providers and market participants because of the nascent space that DEX occupies.
Both CEX and DEX platforms provide users with unique benefits and are set to coexist in the DeFi space going forward, affording users options depending on their trading risk profiles and preferences.
Their trajectories intersect with both adopting features from the other to afford greater user experience and take advantage of technological innovations occurring in the DeFi space.
External pressure from TradFi and regulators continues to exist however both CEX and DEX platforms are only just coming into their own in the financial marketplace and we see a future where cooperation lends itself to greater advances.
Guest post by Hisham Khan from Aldrin
Hisham Khan comes from a decade-long background in managing and building robust and innovative financial and enterprise technology. With an extensive career at Bloomberg and based in New York, Hisham has worked as a project manager with some of the world’s top engineers. It was here where he discovered the transformative impact of cryptocurrencies, and has since left Bloomberg to build comprehensive and accessible trading tools through Aldrin.Learn more >