Besides sounding like characteristics for a roleplaying game like dungeons and dragons or the names of some obscure companies; you might also have heard the words ‘CEX’ and ‘DEX’ tossed around while people are discussing cryptocurrency. In this blog post, we’ll be focusing on the cryptocurrency definitions of the acronyms and explaining the key differences between the two.
What the Acronyms Stand For
CEX stands for ‘centralised exchange’ and DEX stands for ‘decentralised exchange’. In the cryptocurrency world, exchanges facilitate the buying and selling of cryptocurrencies for other cryptocurrencies or fiat (real world) money.
In layman’s terms, they act both as trading platforms and money exchangers. Exchanges make their money via commissions, transaction fees, and numerous other services they offer to their users.
Centralised Exchanges (CEXes)
The definition of ‘centralised’ is ‘drawn toward a center or brought under the control of a central authority’… and this, unsurprisingly, is correct for centralised exchanges. Centralised exchanges are platforms that have been started by enterprising individuals that wish to profit via the facilitation of financial services to cryptocurrency users.
Centralised exchanges act almost as banks. You can deposit your coins with them, some (such as crypto.com) offer cards that allow you to spend your crypto at physical shops, you can utilise their trading platform to make investments and they offer loans or a host of other financial services (leveraged trading simultaneously being one of the most infamous and common financial products offered by exchanges).
Centralised exchanges operate by having you deposit your coins into their central wallet, which brings all assets deposited onto the platform under the central control of the exchange’s operating company. Trades of the deposited coins are then recorded and settled on internal systems.
There are numerous benefits of having CEXes act as banks do, as the middlemen of the cryptocurrency economy.
- CEXes are very friendly to crypto newcomers, with user friendly UIs and relatively low barriers to on-ramp capital into cryptocurrency.
- Because your coins are held by the CEX in their own wallets, if you ever forget your account password then you can simply use their UI to reset your account and access your coins. In contrast, if you ever forgot your own wallet password then you might have lost your coins forever.
- Because many people use them, exchanges have a high degree of liquidity. This means that most users can move large figures fairly quickly, be it selling them for fiat or trading them for another cryptocurrency.
Centralised exchanges are the most common kind of exchange- but they are sometimes criticised as being against the spirit of cryptocurrency. CEXes require ‘know your customer’ verification (that strips away user anonymity) as they present a corporeal entity for regulators to target. As mentioned above, CEXes also require you to deposit your coins into one of their central wallets for you to utilise their services. This takes the coins out of your possession and places them in the hands of the exchange as a middleman. Following numerous high-profile hacks of CEX vaults, some cryptocurrency users are reticent to leave their funds with CEXes, choosing either to use DEXes or simply transferring their funds in and out of CEXes as fast as they can. The (fairly small) risk of losing your coins through no fault of your own (beyond leaving them in the hands of a middleman) is one of the largest downsides of trading using a CEX.
Whether you love the convenience or hate their spirit, CEXes have been crucial for the development of the modern crypto economy. They have made cryptocurrency trades reliable and this stability has been highly beneficial to the space overall.
Some notable examples of crypto exchanges are; Binance, Coinbase, FTX, Huobi, and Kraken.
Decentralised Exchanges (DEXes)
DEXes, by contrast to CEXes, are exchange platforms that are not controlled by a single entity that acts as a middleman. Instead, they are protocols that use smart contracts to settle peer-to-peer transactions. They are the epitome of decentralised finance (DeFi) products, in that you do not have to engage in KYC to interact with the exchange and, as such, you can retain a high degree of anonymity.
Decentralised exchanges act almost like traditional markets. At the DEX, if you want to change your cryptocurrency for another, provided you possess a popular enough cryptocurrency, then you’ll be able to find someone else who has already said they’re willing to swap. This person is likely providing liquidity for the cryptocurrency in question and will be rewarded via a percentage of the trade fee for having facilitated the transaction. Using the market analogy, an Ethereum merchant has set up a stall and will sell you Ethereum in exchange for your Bitcoin… but he will take a percentage of profit for his having set up the stall in the first place. This trade is trustless, as code is executing the deal, and is recorded by the smart contract on the blockchain (so is transparent and auditable).
Decentralised exchanges operate by linking a user’s cryptocurrency wallet to the protocol, thereby giving the protocol permission to see the balance of the wallet and asking for further permission to transfer the coins within. The user can then use the protocol UI to select a cryptocurrency they wish to buy. Provided there is enough liquidity for the deal to take place then the protocol will ask the user for final permission, listing the desired trade size, trade fee, and transaction processing price, before closing the deal.
The main advantages of using a DEX protocol are:
- Peace of mind. Because DEXes don’t have control over your coins (or store your wallet private key) there is no way for hackers to steal your coins.
- Because there tends to be less liquidity on DEXes, algorithms (automatic market makers) calculate the fair price of assets and all transactions are recorded on the blockchain, it is very difficult for human market-makers (otherwise known as ‘whales’) to manipulate the market.
- As mentioned above, no KYC is required for DEXes so users can retain their privacy.
However, there are a number of disadvantages too.
- There are no fiat transactions possible, deposit or withdrawal, which is inconvenient. Some DEXes provide such services in conjunction with on-ramp providers, but users have to KYC for this service through the provider.
- DEXes are quite complex to understand for newcomers to the cryptocurrency space. They represent a steep learning curve in how cryptocurrency actually works and require at least a working knowledge of various crypto concepts.
- Because anyone can list a token for exchange on a DEX, ‘rug-pulls’ are possible, where a whale provides liquidity for a new crypto market (using either a hijacked ticker or a totally fraudulent project) and then, once enough coins have been sold, they remove all market liquidity (pulling the rug from under the market). This leaves the buyers of the token unable to sell- meaning that they have essentially lost their money.
- There are limited trading options on DEXes such as uniswap, though some recent DEXes do now provide trading products such as futures and leverage through the development of new protocols.
- Liquidity providers can sometimes get back less than they invested if the price of the coin they are providing liquidity for sharply drops
- Trades cost more than trades on an exchange.
DEXes can be said to represent both the best and the worst of crypto. At their best, users can exchange their coins anonymously and trustlessly with the highest level of security. At their worst, they can leave users wishing that there was a centralised body, a middleman, that could undo a transaction or provide them with a refund. Ultimately though, with DEXes, the user is fully in control of their coins and is wholly accountable for what they do with them… so it is not the fault of the DEX if a user has a bad experience.
There are numerous DEXes, though the best known is arguably Uniswap. A full list of the largest DEXes can be found here.
CEXes and DEXes both allow for the trading of coins but do so in notably different ways. CEXes are centralised entities that provide a middleman service between users, while DEXes rely on smart contracts to perform their trades. Centralised exchanges will, to an extent, provide a safety net for users and are relatively newcomer-friendly- while decentralised exchanges simply provide users with the tools to trade and expect users to understand what they are doing.
Both kinds of exchange provide key services within the wider cryptocurrency markets and it is impossible to say that one is truly better than the other. However, for newcomers, CEXes do represent a simpler and more user-friendly means of trading- and also the ability to purchase crypto for fiat currency. As users get more confident and competent and start to become more concerned with privacy and full control over their crypto then a DEX will likely become more suitable.