DEX vs. CEX: Which Is Better?
David Akiloon May 30, 2022.
What is DEX, and How Does it Work?
A decentralized exchange (DEX) is a peer-to-peer crypto marketplace where transactions occur directly between traders. The primary function of a DEX is to foster permissionless DeFi transactions between buyers and sellers without the influence of intermediaries. By trading on a decentralized exchange, users avoid mediator hassles since entities like banks, brokers, and payment processors have no power to regulate or control transactions within the system.
How do DEXs work?
DEXs are blockchain-powered applications that facilitate large-scale crypto-to-crypto transactions. Unlike centralized exchanges, DEXs do not allow the trading of fiat for crypto; rather, crypto token holders trade tokens exclusively with other token holders. DEXs are run and powered by smart contracts and do not need intermediaries to help complete trades. Everything is automated, provided the required conditions are met.
DEXs may rely on liquidity pools and smart contracts to power trading on the platform. These liquidity pools contain a basket of locked tokens provided by the users of the DEX, who earn a reward for their liquidity provision. Interested traders simply exchange their cryptocurrencies for the desired tokens available within the pool.
What is CEX?
A centralized exchange (CEX) is a crypto exchange marketplace that facilitates the trading of cryptocurrencies in a centralized manner. They are one of the most popular cryptocurrency exchange operations widely available to traders globally. Its accessibility and the swift nature of transactions amongst day traders and crypto investors make the centralized exchange the go-to exchange for any beginner trader. Also, the fact that they allow buying and selling of crypto via fiat gives CEXs an edge over their decentralized counterparts.
How do CEXs work?
Centralized exchanges let users trade with each other by keeping an order book - a list of traders' buy and sell orders. When a trader deposits funds on a centralized exchange of their choice, the CEX assumes custody of the deposited assets (usually fiat) and issues a comparable quantity of IOU (an informal document that acknowledges a debt one party owes to another) to the trader. After this, CEX conveniently tracks each user's IOUs as they are traded and only turns them into actual cash at the time of withdrawal.
Although CEX has grown in popularity over the years, the platform has faced numerous challenges, including a lack of transparency, an overreliance on KYC procedures (Know Your Customer), a destination point for potential attackers (hackers), and a tool for government censorship.
The Key Differences Between DEX and CEX
- Custodial vs. Non-Custodial: One of the main differences between DEX and CEX is that DEX appreciates the need for users to hold on to their crypto assets as sole custodians. By doing this, users have exclusive control of overall assets. CEX requires that users place assets in their custody before trading. While the DEX approach appears to have merit, it may come with some risks, such as losing control (passwords/log-in keys) over assets.
- Regulations: Most DEXs are open to everyone. They don't force their users to undergo KYC procedures or anti-money laundering (AML) standards. This approach provides a layer of anonymity for traders and users of the platform. On the other hand, CEXs rely heavily on regulatory bodies to thrive. Giving out personal information to participate in crypto trading is usually a big turn-off for investors that wish to remain private.
- Liquidity: Another difference between DEX and CEX is liquidity. While DEX is a new entrant into the financial ecosystem, it has to struggle to grow its liquidity pool by leveraging its users and providing incentives for liquidity provision. This in itself is a significant difference in that CEXs have one of the largest pools of liquidity because they work with bigger investors when compared to DEXs.
Is DEX or CEX More Profitable?
Crypto exchange profitability rests on several factors, such as ease of navigation, user experience, trading fees, etc. Rookie traders may find that CEXs are simpler to navigate. On the other hand, DEXs are likely to appeal to more seasoned traders who already have a firm grasp of the crypto market and seek better control over their holdings.
DEXs provide users with complete control over their assets and some degree of anonymity. When using CEXs, users are not in complete control of their assets, which goes against one of the core ethos of cryptocurrencies: decentralization. DEXs also charge relatively lower trading fees compared to CEXs. Depending on the trade, the trading fees could make a difference between seeing huge profits or minimal gains.
Expert traders may decide to combine the two crypto exchange models depending on their goals. For instance, when an individual wishes to engage in active trading or buy and sell transactions, they may use a CEX. After that, they turn to DEXs for long-term asset storage.
What Makes DEX Better Than CEX?
Most traders tend to lean towards DEX for the following reasons:
- With DEX, users are assured better security and complete ownership and control of assets.
- They also encourage the peer-to-peer exchange of cryptocurrencies or liquidity pool-powered trading without middlemen.
- Decentralized exchanges prevent market manipulation, protecting users from fake trading and wash trading.
- DEX also does not require customers to fill out know-your-customer (KYC) forms, offering privacy and anonymity to users.