Centralization in a decentralized ecosystem: DEX vs CEX
Getting into crypto usually means spinning up a crypto app on your phone and buying your favorite currencies using your favorite payment method, but with convenience also comes risk.
ByJasper Verbeet — Explainers
4 min read
In the ideal scenario, the phenomenon of decentralization in blockchain refers to giving back supervising and decision-making powers from centralized authorities, be it an individual, corporation, or group of people, to a dispersed network of users or direct beneficiaries of the system. These could be local neighborhoods, but also communities involving similar interests.
Centralized exchanges (CEX) were the first to establish themselves in the cryptocurrency market, but recently a new type of exchange has made headways for itself, the decentralized exchange (DEX). At present, with more than 16,000 crypto assets traded across nearly 450 exchanges, we see decentralized exchanges slowly taking market share every month.
But, what are the differences between a CEX and a DEX, and how do you use them?
DEX versus CEX: What's the difference?
When you buy assets from a centralized exchange, the exchange matches you as a buyer with sellers through an order book - the same way it happens in online brokerage accounts for regular stocks. These centralized exchanges will hold your funds, both fiat and crypto, and let you exchange them for hundreds of virtual coins. Usually, they also supply services for buying cryptocurrencies with fiat money with a slight markup. All transactions are stored in their databases and thus are private. Some popular ones are Binance, Crypto.com, and Coinbase.
In a DEX, on the other hand, there are smart contracts that run as an autonomous financial protocol directly on the blockchain. Due to the lower volume and technical challenges, most DEXes use an Automated Market Maker (AMM) instead of an order book to match buyers and sellers. Because these smart-contract-powered applications live directly on the blockchain, you need a wallet to interact with them, but with the advantage that all transactions stay public, and thus tampering is less likely. Some popular ones are Uniswap, 1Inch, Curve Finance, and Pancakeswap.
Different exchanges, different risks
Is tampering with data by exchanges a valid concern then? Well, yes. Since centralized exchanges deal with a large volume and significantly high number of assets, they have considerable influence over the crypto market. Their relative opaqueness regarding transactional data caused some instances where CEXes have manipulated the market with insider trading, fake volume, and price manipulation.
Also, the lack of inherited security from blockchain technology have made them a massive target for bad actors. Centralized exchanges, like the Coincheck, Mt. Gox, BitGrail, NiceHash, and Bitfinex, have been at the center of some of the largest crypto hacks in history.
Does this mean you should not use them? Well, maybe not the ones listed above, but popular centralized exchanges are the recommended exchange for most users. Currently, 88% of all cryptos worldwide are traded on centralized exchanges, and for a good reason. We will explain the practical application of a CEX versus a DEX in a minute.
DEXes solve some of these issues with transparency, publicly audited code, and the cryptographic security offered by the blockchain because of their very nature. And because they don't hold the users' funds, which are stored in their private wallets, there is a lower incentive for hackers to target these exchanges.
On the other hand, given their influence most CEXes won't allow just any token to be listed on their exchange. Usually these must be well established and go through and extensive screening process. This is not the case with DEXes, where everyone can list their token, some of which are vulnerable to rug pulls, or might not have enough liquidity to be sold at any time.
The open nature of DEXes make them a popular starting point for Initial Coin Offerings (ICOs).
What should you do?
Most people buy their crypto currencies on centralized exchanges. Nowadays, all of the popular ones are well regulated and secure. Furthermore, most tokens on them are well established making them a relatively safe endaver.
If you're looking for a bigger risk appetite and have some technical knowledge, you might look to install a private wallet, like Metamask, which you can use to interact with these DEXes, buy an NFT or join an ICO on different blockchains. All of which we will discuss in a future article.
Decentralized exchanges match the narritive of blockchain better but are relatively hard to use, and usually unregulated. Which is why, as long as you stay with popular options, most people are better off with centralized exchanges. However, most new projects start on DEXes and if you like being early, it might be worth looking into.
If you are developing a decentralized exchange of your own, want to list your cryptocurrency, or are building a unique Defi product, you might face high complexity technical challenges. At Byont, we help businesses and startups globally successfully enter and navigate this blockchain ecosystem.
No matter at what stage you are, we provide end-to-end assistance from concept to development. We have successfully assisted startups and businesses in developing new business models, deploying smart contracts across multiple chains, token launches, and NFT publications.