Centralized vs. Decentralized Exchanges (CEX vs. DEX)
People are actively exploring the world of cryptocurrencies. The best way to do this is using big exchanges like Coinbase or Binance. But as they continue to explore the world, they come across Exchanges like Uniswap.
People research and find that some say Uniswap and the like are more in line with crypto ideals. Others say Coinbase, Binance, and similar exchanges have more to trade and are easier to use. So what do decentralized exchanges like Uniswap have that centralized exchanges like Coinbase don't? We'll explain the fundamental differences between centralized (CEX) and decentralized (DEX) exchanges to clear the ambiguity.
CEX is an exchange where an intermediary performs and oversees the transactions and manages the assets. Whenever you exchange one currency for another on a centralized exchange, the transfer is not directly between you and others. Instead, the Exchange manages the trade. Imagine you are living in a village where people do not use money but trade goods. If you are growing potatoes, you may want to give some potatoes to the cow farmer for milk.
One day, a group of villagers set up a market in the village. The governed market operates 24 hours a day, seven days a week, allowing for a more organized exchange of goods, creating security, and you no longer have to worry about not exchanging your potatoes. The villagers who created the market also own the market. They make a profit from every trade people make.
You give potatoes to the market and drink milk. Once the cow farmer needs potatoes, they go to the market to trade. But keep in mind that, in the cryptocurrency world, you can't take the potatoes and milk, also known as crypto-assets, home and store them in a personal safe. Instead, even if you own them, they remain on the market in a safe with your name on them. But we'll come back to this crucial aspect later.
A DEX is a type of Exchange in which there is no third party. In a DEX, you hold your assets instead of entrusting them to a third party, such as a bank. Let's go back to our town. There is no centralized market in the village square controlled by a specific group. Instead, the villagers create a huge automated safe that no one governs. Depending on current potato/milk prices, you can only take from the safe as much as you give, depending on current potato/milk prices.
Then, whenever you need a specific good, you go to the huge safe, make the transfer, take the goods home and store them in your safe. Now that we have a better idea of a centralized and decentralized Exchange, let's delve into the fundamental differences, advantages, and disadvantages.
Diversity of crypto assets
There are more than 4,000 different cryptocurrencies on the market as of 2021. An asset must comply with security protocols, have trading activity, and meet legal standards to get listed on the CEX.
On a DEX, you can list anything, implying more risk, but it also means you could trade new and in-demand assets. Everyone has milk and potatoes, but the price of mangoes could soon increase. Make sure you do your research, or you'll end up with a bag of rotten assets.
Security and Privacy
At a CEX, you're less likely to run into a scam. That is, you do not expect to trade potatoes for milk and realize it's water instead of milk. People buy unknown coins and lose their entire investment because the project ends up being fake, and the scammers get away with millions of crypto assets.
Similarly, your safe box, also known as a wallet, is in the hands of the Centralized Exchange, implying that if you forget your wallet password, you can ask the Exchange to reset your password.
In the DEX world, if you get scammed, there is no way to rectify it. Also, since you own your wallet, you can't reset the password if you forget your password and your initial passphrase (a set of random words that only you know).
But imagine that one day the police come to your village and consider the centralized market exchange illegal. Or a group of thieves (hackers) breaks into the market. Remember those goods you need to store in the personal safe inside the stock exchange? It's all gone. But your neighbor, who traded on a DEX, keeps all your assets even if the DEX shuts down.
CEXs are like any other large service on the Internet such as Facebook, Twitter, etc. They use established technology that is more stable and has far fewer hiccups and hiccups for the end-user.
One of the main flaws of DEX technology is scalability. A blockchain network depends on the transaction load it can handle before reaching its limit. For example, as of May 2021, Ethereum handles 30 transactions per second. Card giants like Visa handle about 1,700 transactions per second (although Visa claims it can handle 24,000 transactions).
Fortunately, blockchain is a rapidly evolving technology, so the limits faced by DEXs are likely to be less significant soon. While a centralized exchange is easier to use and theoretically more secure, a decentralized exchange is a new technology that will likely become the standard in the future.
But if you are actively exchanging bitcoins and other crypto assets, you are thinking more about making money short-term instead of holding coins for a long time. CEXs are a safe introduction to the world of cryptocurrency trading in terms of day-to-day profits, while DEXs is a riskier place where you can reap higher rewards if you play the game right.
The bottom line is to do both. And remember the golden rule of crypto trading; never invest in something you are not willing to lose. Otherwise, you'll end up without the potatoes you worked so hard to grow and with a bag of spoiled milk and rotten cryptos.