Centralized vs Decentralized Exchanges
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Centralized vs Decentralized Exchanges

6 months ago

CoinMarketCap Alexandria explains the difference between centralized and decentralized exchanges — and who should use which one.

Centralized vs Decentralized Exchanges

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As a cryptocurrency trader or investor, you have the choice between centralized and decentralized exchanges.

But how are they different?

And which one should you choose?

In this guide, CoinMarketCap Alexandria covers the difference between centralized and decentralized exchanges. You will learn:

  • What defines a cryptocurrency exchange
  • What a centralized cryptocurrency exchange is
  • What a decentralized cryptocurrency exchange is
  • The eight differences between CEXes and DEXes
  • The trading volumes on CEXes and DEXes

At the end of the guide, you will know precisely when you should use a CEX and when you should use a DEX.

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What Is a Cryptocurrency Exchange?

A cryptocurrency exchange is simply a place to buy and sell crypto. Strictly speaking, a cryptocurrency exchange doesn't have to be an online platform. There are also physical crypto exchanges, although they are far rarer than their online counterparts.
A crypto exchange offers different trading pairs. For example, the most popular trading pair is BTC/USD, but exchanges also offer BTC/EUR, ETH/USD, and countless other pairs. Trading pairs on decentralized exchanges are always between two cryptocurrencies, such as ETH/USDC.
Finally, a crypto exchange can offer either spot trading or futures. Spot trading refers to the purchase of cryptocurrency, while futures trading refers to the right to purchase cryptocurrency. In other words, in spot markets you buy crypto, but in futures markets, you speculate on the price movements.
You may also check out our guide on how to trade futures on Binance!

What Is a Centralized Cryptocurrency Exchange (CEX)?

A centralized crypto exchange is run by a third party, monitoring and facilitating transactions and securing assets. The exchange provides the necessary infrastructure for market participants to conduct transactions. These transactions are generally settled off-chain on a centralized server the exchange operates.

Furthermore, centralized exchanges are (mostly) regulated by financial authorities and have to operate under KYC and AML regulations to ensure their operations are legal.

What Is a Decentralized Cryptocurrency Exchange (DEX)?

A decentralized cryptocurrency exchange is not operated by a central authority but runs on a system of smart contracts that allows the exchange to function without centralized oversight. This makes decentralized exchanges permissionless, meaning anyone is free to join without requiring permission from the exchange. Thus, decentralized exchanges have no KYC or AML regulation.
Decentralized exchanges also operate on-chain and have a different mechanism for matching and settling trades. Instead of trading against other market participants, your trades are matched by an automated market maker, a system providing liquidity for trading pairs of cryptocurrencies.

Differences Between a CEX and a DEX

Main Features

A CEX is faster and easier to use. Centralized exchanges offer a slick user experience with clean interfaces and are straightforward to sign up for and trade on. Although you have to pass KYC to use a CEX, users can choose from different deposit and withdrawal options like cryptocurrencies, credit cards, or wire transfers. Trades on CEXes are settled near-instantly, which contributes to the smooth user experience.
DEXes are clunkier, slower, and require more experience by the user to navigate them. You can trade only cryptocurrency pairs on decentralized exchanges, which means you have to obtain crypto elsewhere if you want to trade on a DEX. Credit card deposits are generally not an option, although some wallets like MetaMask have integrations with payment processors that allow purchases by credit card. Furthermore, trades can take several seconds to settle because they are processed on-chain. On the other hand, users retain custody of their assets when trading on a DEX.

Control

On a CEX, the exchange retains custody of the assets. This means users rely on the exchange to honor its commitment and process transfers of their cryptocurrency. They do not have control of their private key, so the exchange can theoretically confiscate their assets at any moment. In other words, a CEX works similar to a bank, which is why hardcore crypto believers swear by the manifesto not your keys, not your coins.
On a DEX, you as the user retain custody of your private key and thus your cryptocurrency. A DEX never obtains custody of your crypto assets. Instead, they always remain in your wallet and thus under your control.
Conclusion: On a CEX, the exchange has ultimate control of the cryptocurrency; on a DEX the user.

Security

Centralized exchanges are quite frequently the target of hacker attacks, as the infamous examples of Bitmart, Mt. Gox, and several hacks by the Lazarus Group show. Because of their architecture, centralized exchanges provide a bigger target for malicious actors. Decentralized exchanges can also get hacked, although hackers can only target individual smart contracts and not the exchange as a whole. Thus, they are generally considered safer, although there have also been DEX hacks. If you are not a liquidity provider, you retain custody of your assets on a DEX and are thus not at risk of hacks.
Conclusion: Both CEXes and DEXes can get hacked, but your funds are less at risk on a DEX.

Fees

Even though you often read that DEXes are cheaper than CEXes, that is not entirely accurate. Decentralized exchanges may have lower maker and taker fees for individual trades but settling the trades on-chain often results in higher total costs than on a centralized exchange.
For instance, if you want to trade on a DEX, you pay gas fees for several steps like approving transactions, swapping the tokens, potentially wrapping tokens, etc. In addition, slippage may cost you money if the DEX cannot fill your order at the price and size you requested.
Conclusion: A CEX charges fees for trading and withdrawals, but a DEX can be overall more expensive due to gas fees.

Variety

The variety of trading pairs on CEXes depends on the exchange. Some exchanges like Binance or KuCoin are famous for listing a lot of altcoins, while others offer significantly fewer cryptocurrencies. However, CEXes offer the possibility to trade crypto against fiat currencies.
DEXes provide a wide variety of crypto-to-crypto trading pairs. Since DEXes are permissionless, anyone can provide liquidity for a new trading pair and start a new market. You can not trade crypto against fiat currencies on decentralized exchanges, only against stablecoins.
Conclusion: DEXes offer more variety but no trading against fiat currencies.

Risks

The problem wth CEXes are that users give up custody of their crypto and these exchanges are more vulnerable to hacks. Almost all of the big crypto exchanges have experienced hacker attacks while giving up custody means your account could get frozen for no reason even if you passed KYC requirements.
The main risks of a DEX are related to liquidity providers. If a trading pair is particularly volatile, the liquidity provider may suffer from impermanent loss. Furthermore, there is a risk of rug pulls on DEXes. Since decentralized exchanges list tokens without auditing them, token holders and liquidity providers may experience sudden losses if a lot of liquidity is removed from a trading pair.
Conclusion: On a CEX, you can be hacked or lose access to your cryptocurrency, while on a DEX you may get rugged or experience impermanent loss.

Regulation

CEXes are regulated and have to comply with KYC and AML standards to prevent money laundering and financing terrorist groups. Some centralized exchanges apply only lax KYC, but completely KYC-less centralized exchanges pretty much do not exist anymore.
DEXes are unregulated due to processing all their trades on public blockchains. Since they don't act as financial intermediaries or counterparties but only provide the infrastructure in the form of smart contracts, financial authorities have thus far been unsuccessful in regulating them. However, that may not be the case forever.
Conclusion: CEXes are regulated and you have to pass KYC, DEXes are (for now) unregulated.

Liquidity

Centralized exchanges have much higher liquidity and allow traders to conduct trades up to tens of hundreds of millions of dollars for the most liquid cryptocurrencies. Decentralized exchanges have much lower liquidity due to their on-chain nature. This results in slippage, where large orders can only be completed at worse prices than traders seek. Thus, traders can de facto incur higher costs on DEXes if they wish to trade significant sums.
Conclusion: CEXes are much more liquid; on DEXes you may often experience slippage if you are trading bigger sums.

You may also check out our list of the best centralized and decentralized exchanges!

Trading Volume on a CEX and a DEX

The Block, a crypto analytics company, provides an interesting breakdown of the trading volume on centralized and decentralized exchanges. For example, we can see that the trading volume on decentralized spot markets is only a fraction of that on centralized exchanges:

Decentralized exchanges only became popular around 2020 with the emergence of decentralized finance. Trading volumes have so far topped out around $200 billion and have followed the overall market capitalization of cryptocurrencies:

The most popular decentralized exchange is Uniswap, with more than half of the trading volume distributed across its V2 and V3 versions:

Conclusion

There is no clear winner between centralized and decentralized exchanges. One is not better than the other, but some traders may prefer a CEX to a DEX and vice versa. Many crypto traders use both, as certain tokens can only be found on DEXes and CEXes provide entry and exit points to cryptocurrencies and the regular financial system.

As a conclusion, below is a TLDR overview of the main differences between centralized and decentralized exchanges.

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