Cryptocurrency exchanges are essential services that every crypto trader or investor uses regularly to buy, trade, or even cash out their cryptocurrencies.
Basically, they facilitate buying cryptocurrencies with your local currency or swapping one cryptocurrency for another.
And there’re two broad categories of cryptocurrency exchanges: centralised and decentralised exchanges.
Below, we discuss each of them in detail.
What is a centralised exchange (CEX)?
A centralised crypto exchange is a platform that aggregates its users’ buy and sell orders in an order book and uses proprietary software to match and execute these orders accordingly.
Centralised crypto exchanges function as intermediaries between buyers and sellers and make money by charging a fee on all trades and withdrawals on the platform.
They’re similar to stock exchanges or forex brokers in traditional markets, except that they only deal with cryptocurrencies.
Advantages of a CEX
- They’re more convenient, faster, and easier to use, especially for new investors.
- CEXs have the biggest liquidity and trading volume. This means it’s easier to trade large amounts without significantly affecting the price of the asset.
- Less expensive to trade on. CEXs usually have the lowest trading fees.
- Better regulated and supposedly less prone to exit scams.
- CEXs have the largest collection of crypto assets or trading pairs to trade and support multiple chains than DEXs.
- Opportunity to recover funds if you lose your password or access to your account. With DEXs, if you lose your private keys or access to your wallet, your funds will be lost forever.
- Supports both fiat on-ramp and off-ramp. Meaning you can deposit fiat to buy crypto and withdraw your crypto to fiat. Some CEXs even have fiat-to-crypto trading pairs like BTC/EUR and BTC/USD.
- Provides advanced trading and charting tools for experienced and professional traders.
Disadvantages of a CEX
- Centralised exchanges are a single point of failure and susceptible to hacks as they run on a centralised server and store all their users’ funds in their own publicly known hot and cold wallets. And if the exchange gets hacked or exploited, you may lose your funds.
- You’re trusting the exchange to hold your crypto assets and act in your best interest and due to human nature, they usually will use your funds for their own gains. And if they lose your money and go bankrupt as we saw in 2022, you alone suffer the loss.
- Government interference in the operations of centralised exchanges is increasing every day via regulations. If you value your financial privacy and freedom, then centralised exchanges are a bad idea as government oversight on them is ever-increasing. And it’ll only take a single click of a button to freeze your account.
- You don’t own or control your crypto assets on a centralised exchange. They belong to the exchange who can often use them for their own gains. And you may not be able to access your money whenever you like, especially if the exchange is having technical issues or goes bankrupt.
- Centralised exchanges have proven to be prone to fraud and unethical practices such as insider trading, wash trading, embezzlement, market manipulation, etc. This can create an unfair playing field for traders and can lead to losses.
The best way to use a CEX
The biggest appeal of centralised exchanges is convenience. They offer greater convenience and tools for both new and professional crypto traders or investors.
That’s why they will continue to stay relevant despite their incessant abuse of customers’ trust and the associated risks they expose you to.
In other words, they are a necessary evil and below are the best way to use them to minimise your risk exposure.
- For those buying crypto with fiat, buy and transfer the asset to your own wallet instantly and leave.
- If you’re using a CEX to cash out, make the transaction and get the money into your bank account and leave.
- And if you’re using a CEX to convert one cryptocurrency to another, make the conversion and transfer the new asset to your wallet immediately and leave.
- As a career trader using a CEX to trade crypto, make sure you keep just the amount you need for your trades on the exchange and preferably do not keep all your trading funds on a single exchange. Diversify.
- If you’re using their investment products, deposit only an amount that will not ruin you if lost to bankruptcy, hack or outright scam.
- Centralised exchanges are not a place to “store” your crypto assets, your wallet is.
- Trade on CEXs only when absolutely necessary, and when done, move your funds on-chain to a wallet that you control.
- Use only highly reputable CEXs like Binance, Coinbase, Kraken, Bittrex, etc. Avoid the shady ones.
- When in doubt, go on-chain and use only DEXs until the doubt is fully cleared.
What is a decentralised exchange (DEX)?
Decentralised exchanges are crypto exchanges that facilitate peer-to-peer crypto trading, mostly using the automated market maker (AMM) model.
Based on the AMM model, users can provide liquidity by depositing their tokens into liquidity pools to support buying and selling of the assets in the pool by traders.
These liquidity providers then earn a sizeable share or all of the trading fees generated from the pool.
Advantages of a DEX
- Anonimity and privacy. DEXs do not require you to create an account or complete KYC. And you stay anonymous except a wallet address can be linked to your real-life identity.
- No single point of failure. DEXs don’t rely on a central server to store users’ funds that hackers can target.
- Self-custody. DEXs allow you to trade directly from your wallet by interacting with smart contracts. You maintain full custody of your crypto assets at all times, unlike a CEX that holds your coins for you.
- Decentralised and open source. Most DEXs are decentralised with third-party audited and open-source codes. All CEXs are not.
- DEXs are more resistant to censorship and government overreach as they do not have a central authority that can be pressured to censor certain transactions or freeze users’ accounts.
- They’re globally accessible, which makes them more convenient for users in countries with strict regulations and oppressive governments.
Disadvantages of a DEX
- It’s more expensive to trade on a DEX than a CEX as you pay a higher trading fee in addition to on-chain transaction fees for every trade.
- A DEX has the same scalability and other limitations as the chain it’s built on. If the chain is slow or has high gas fees (like Ethereum), the DEX will be slow and even more expensive to trade on as well. That’s why most of us use DEXs on BSC and other fast and low-cost chains.
- You can only trade tokens native to the chain on which a DEX is built. On Ethereum, you can only trade ETH and ERC-20 tokens, on BSC; BNB and BEP-20 tokens, etc. You can’t trade tokens on other chains on a DEX directly.
- Only a few advanced DEXs like Biswap supports buying crypto with fiat, most DEXs don’t.
- DEXs do not offer direct fiat/crypto trading pairs (EUR/BTC) nor allow you to withdraw your crypto assets directly to fiat. For now, only a few CEXs offer these services.
- Limited trading tools. Most DEXs do not support limit orders, stop losses, advanced charting, etc. However, some innovative DEXs like Biswap have started providing advanced tools for professional traders but they still have a long way to go.
- Prone to exit scams as DEXs are unregulated and most are created and managed by anonymous or obscure teams that can disappear into thin air anytime.
The best way to use a DEX
The biggest appeal of DEXs is the decentralisation, anonymity, and control that they provide users. Which is all crypto stands for.
- If you value decentralisation and want to avoid KYC or protect your privacy, then use DEXs for your crypto trades.
- DEXs are more suitable if you only do occasional trading and for staking, liquidity mining, and other DeFi investment opportunities.
- Some more advanced DEXs like Biswap now allow you to buy crypto with fiat using your bank card and also provide professional trading tools. You can use them instead of a CEX.
CEXs vs DEXs: The major differences
Centralised exchanges are crypto trading platforms that are run by a single entity and usually require you to deposit your funds into the company’s own bank account or wallets to fund your account.
They act as intermediaries between buyers and sellers, automatically matching orders using special software to facilitate trades.
Decentralised exchanges, on the other hand, are run directly on a blockchain such as Ethereum or BSC, where users can buy and sell cryptocurrencies directly with one another without the need for an intermediary.
Instead, trades are facilitated using smart contracts on a blockchain network, which allows for greater transparency and security.
They’re relatively more complex to use though, especially for beginners, and they tend to be slower compared to a CEX.
Below are the major specific differences between a CEX and a DEX:
- CEXs are centralised and run on a centralised server controlled by a single entity DEXs are decentralised and run directly on a blockchain network.
- CEXs are closed source and internally audited while DEXs are mostly open source and audited by a third party. For example, Biswap is audited by Certik.
- CEXs have custody of your crypto assets while DEXs allow you to maintain custody of your assets at all times.
- CEXs can use your crypto assets on their platform to make more money for themselves. DEXs can’t because they don’t hold your tokens.
- It’s cheaper to trade on CEXs than on DEXs because they usually have lower fees or slippage and tighter spreads.
- Trades on CEXs are faster compared to DEXs which are only as fast as the blockchain network they’re built on.
- CEXs provide you with more sophisticated trading tools compared to the basic trading functionalities of a DEX.
- Currently, CEXs are mostly regulated by the government while DEXs are not.
- CEXs are more vulnerable to hacks and security breaches, as they have a central point of failure but DEXs are considered to be more secure, as they do not have a central point of failure that hackers can target.
- Most CEXs require you to complete KYC and pass their Anti-Money Laundering (AML) checks to use their platform. None of that is required when you use a DEX.
- CEXs tend to have higher liquidity than DEXs, as they have more users and a wider variety of crypto assets for trade.
Why the future belongs to DEXs
With the massive failures of centralised exchanges and custodial services in 2022, there’s now a great shift towards self-custody and DeFi.
People are moving their crypto assets from centralised exchanges to their own wallets to use in DeFi and avoid the increasing abuse of trust by centralised entities.
After all, decentralization and self-custody are the two main reasons why the crypto market existed in the first place.
And with the majority of DeFi activities happening on DEXs, we should see an increase in traffic and usage of these protocols in 2023 and beyond.
Furthermore, as people move to DEXs to do business on-chain, liquidity and trading activities on these exchanges will continue to grow and so will the earnings for liquidity providers, stakers, etc.
Why I recommend trading almost entirely on DEXs
Crypto gives you the opportunity to be your own bank.
When you use centralised exchanges, you’re throwing all that freedom and control away by giving your assets to some ‘banker’ to play with.
And if they suffer a hack, exit scams, or go bankrupt, you’ll lose all or a sizeable portion of your funds on the exchange.
In fact, your crypto assets on an exchange are not yours. They belong to the exchange until you withdraw them to your own wallet.
However, with a DEX, you maintain full control and ownership of your crypto assets at all times.
Furthermore, some DEXs like Biswap reward you for trading on their platform, no CEX does that.
My favourite DEX: Biswap
One of my favourite DEX of all time is Biswap —the second-largest DEX on BSC, with the lowest fees, advanced trading tools, several lucrative and passive income opportunities, etc.
For example, this article is entered into the Biswap Space Agents Program (SAP) for a chance to earn up to $2,500 every month by publishing content about the project.
Furthermore, you can get up to 50% trading fee reimbursement, 20% referral commission, etc.
You can follow the project on their social media communities or check out my in-depth Biswap Review article to learn more.
Exchanges are essential services that every crypto trader or investor uses every day.
As such, it’s important for you to know the differences between the two major types of crypto exchanges out there:
- Centralised exchanges (CEXs)
- Decentralised exchanges (DEXs)
In this article, we have discussed the advantages and disadvantages as well as the major differences between the two
We’ve also highlighted why you pay more attention to DEXs in 2023 and beyond as more people lose trust in centralised entities and begin to take DeFi into consideration as the better alternative.
Now, over to you. What did I miss?
What other differences between CEXs and DEXs will you add to the above list? Share with us in the comments section below.