Table of Contents

  • What Is a Decentralized Exchange?
  • Important Differences Between a Centralized and a Decentralized Exchange
  • The Decentralized Exchange: The Future of Crypto Exchanges?

Centralized exchanges have long played a critical role in finance. Yet, the recent emergence and growing popularity of decentralized exchanges (DEXs) has led to a popular question:

Which is better? Centralized exchanges (CEXs) or their decentralized counterparts?

Despite what decentralized finance (DeFi) advocates have to say, CEXs come with their own advantages and drawbacks. Let's look at what they are and compare their tradeoffs against DEXs. But before we do, we define DEXs first.  

What Is a Decentralized Exchange?

A decentralized exchange (DEX) is a marketplace that facilitates the peer-to-peer exchange of crypto. Unlike CEXs, DEXs do not involve a third party. This means they appeal particularly to anyone wanting to transact without having to go through a bank, for example. Instead, DEXs use smart contracts, algorithms that self-execute once preset conditions are met.    

Because DEXs are a novel financial instrument made possible thanks to DeFi, their infrastructure affords a bit more flexibility. For instance, while the earliest DEXs relied on order books, much like their centralized counterparts, they've since emerged with a variety of ways to structure themselves, which influences how they provide liquidity to users. 

Since we're still in the early developmental stages, DEXs like Uniswap and Sushimay feel a bit clunky and limited. Centralized exchanges like KuCoin and Binance may grant users a smoother user experience. 

Another key difference is that CEXs can provide currencies from different blockchains. The majority of DEXs still run on the Ethereum blockchain.

However, some other blockchains have released their own DEXs. They include PancakeSwap on Binance Smart Chain and Zero Exchange on the Avalanche blockchain. (Zero Exchange acts more as a bridge between chains, and can thus be considered chain-agnostic.)    

Important Differences Between a Centralized and a Decentralized Exchange

Let's take a closer look at several other critical differences between a CEX and a DEX by breaking them down.

Trust. CEXs act as a trusted third party to facilitate trades. They leverage their established reputation to maximize investor confidence. They also provide a more understandable UI for traditional investors too.

In contrast, with a DEX, greater ownership over your own assets requires you to learn more about how it all works. You must also carry a heightened appetite for risk. Greater knowledge affords better security and protection from malicious third parties — but it is a cost of self-custody (one that's still very much worthwhile).   

Security. CEXs also provide more traditional forms of security, some in the way of insurance, others in the form of regulatory compliance. Compliance usually includes Know Your Customer (KYC) verification and anti-money laundering (AML) provisions. Such provisions can prove to be an annoyance for many crypto users, especially for privacy advocates. (More on this below.)

DEXs can also provide security, but in another form: preventing market manipulation. Thanks to blockchain technology, all transactions are recorded on the chain, so they're traceable. A centralized exchange platform does not provide the same level of transparency, and this comes with its own risks.   

Privacy is a major point of support for DEXs because they don't require users to undergo any verification measures whatsoever. Because DEXs are permissionless, their peer-to-peer transactions allow traders to execute trades with a certain degree of anonymity (i.e., pseudonymity).

This mostly affords decentralized exchange users convenience of considerable magnitude. After all, to trade on a DEX all that is typically required is to connect your crypto wallet.   

Liquidity. CEXs tend to be able to provide a much greater amount of liquidity (and in turn, trading volume) compared to DEXs. This is partly because users can't purchase crypto with fiat directly on DEXs. Hence, traders are forced to transact initially via a CEX to access their preferred fiat-crypto pairs. On DEXs, users can trade only crypto-crypto pairs.  
As mentioned, DEXs assume a variety of structures for users, which mainly affects how the exchange secures liquidity. Having started with open books, DEXs have since transitioned to adopting the automated market maker (AMM) model as well as liquidity pools, swaps, a combination of these and various other financial instruments. 
Barrier to entry. People in many countries are left unbanked through no fault of their own. Because DEXs offer trading based on peer-to-peer transactions, these population groups can still trade crypto without having to be excluded simply due to the country they reside in.    

Moreover, many CEXs have become notorious for charging exorbitant fees. DEXs often charge such a negligible trading fee that it does not warrant the attention of traders.   

Other offerings. Both popular centralized and decentralized crypto exchanges continue to come up with novel tools. These tools allow traders to squeeze even more out of the crypto assets they already own. 

CEXs like KuCoin and Binance provide trading bots to their users as well as passive-income opportunities like staking. DEXs, by comparison, provide users with options to participate in yield farming and liquidity pools.   

The Decentralized Exchange: The Future of Crypto Exchanges?

There are many more differences between CEXs and DEXs, but we've covered the most important ones here. You should be able to tell by now that there are tradeoffs to using each one. That's why we recommend using both, depending on your purpose, location and circumstances.

For instance, if you're purchasing crypto with fiat, it's best to find a CEX you're comfortable using, one that's available in your country. But if it's small-cap coins you're after on the Ethereum blockchain, Uniswap might be your best bet. 

It really does depend on your needs. The cryptocurrency market is evolving rapidly. More and more novel DeFi financial instruments are looming on the horizon. 

But that won't mean the end for CEXs — awesome DeFi innovations will no doubt bleed into centralized cryptocurrency exchanges as well. 

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