Earlier this year on April 29th, cryptocurrency analytics firm DataLight published a report showing website traffic data for cryptocurrency exchanges. The report found that over 22 million people from the US alone visit the 100 most popular exchanges every month. Cryptocurrency Exchanges are a necessary and vital part of the blockchain ecosystem. Historically, cryptocurrency exchanges were centralized – they operated as middle-men for you and whomever you’re trading with, similar to a bank. However, centralized exchanges are contentious, since by principle they stand against the decentralized nature of blockchain technology. Centralized exchanges have also come under fire for being the weak points of massive security incidents, resulting in tens of millions of dollars lost for their users. As a result, decentralized exchanges have begun popping up as a challenge to the real and ideological shortcomings of centralized exchanges.
However, trades on centralized exchanges still make up over 99% of all cryptocurrency transactions. It stands to reason that CEXs still have functions and tricks that DEXs currently do not have.
Here are some key differences between CEXs and DEXs, and why people might choose one over the other for now.
There are distinct functional differences between both types of exchanges. When it comes to Centralized Exchanges (CEX), they operate similar to banks today. Trades involve third-party operators that are trusted to be in charge of your assets, similar to how banks are in charge of the funds in your bank account.
Traditionally, you hold funds in a bank because a bank will offer security and monitoring measures, making it more pragmatic and safe for you to store your money with them rather than under your mattress. The same applies to CEXs. Losing a private key to your own wallet can be an unrecoverable loss, but if your funds are with an exchange, then retrieving access to your money is as simple as verifying your identity.
They also give users the opportunity to make transactions with traditional (fiat) money with a central authority, an option that DEXs currently do not provide.
Now looking at DEXs, the most significant difference is that it operates without any intermediary, and instead operate on a semi-autonomous basis through smart contracts. A DEX does not store any funds or information. It only serves as a matching and routing layer for trade orders – a matchmaking service for buyers and sellers.
DEXs at this point also do not currently offer the same range of tools to trade. For instance, many DEXs currently do not offer margin trading, stop loss, or lending capabilities – functions that CEXs do offer. Users looking for more advanced trading options may find the functionality of DEXs less than sufficient at this current point in time.
In a CEX, the exchange controls the entire system, platform, and infrastructure. To trade on any centralized exchange, users will have to use and store their funds on an exchange issued wallet, of which the private keys to this wallet will be held by the exchange. If there is a hacker attack or DDoS attack, the CEX exchange will typically suspend activity in order to secure funds. However, since all the money is stored on the accounts of the CEX, a successful attack on a CEX can and has in the past, lead to a massive amount of coins being lost to hackers. Notable examples include the hacks on Mt Gox, Coincheck, and most recently on Binance.
Also, since CEXs offer fiat to cryptocurrency exchanges, they are also usually regulated by local laws. A centralized exchange must follow the regulations given by a country and perform identity verification of its users. Users are thus required to hand over information pursuant to KYC and AML regulations. Knowing that CEXs have points of failure for hackers, divulging information may be a point of concern for users looking to trade on centralized exchanges. In 2017, 31,800 Bithumb users had their personal information stolen by hackers.
So whilst centralized exchanges currently enjoy greater levels of functionality than DEXs, users using any centralized exchange will have to place their trust in the security measures put in place by that exchange.
The main draw that DEXs have over CEXs is precisely in the aspect of security. Since the middleman is cut entirely out of the trading process, individuals also do not have to entrust their funds to the exchange – the funds are kept in your personal wallet. What this means is that trust in the system is not necessary for the system to function – DEXs are trustless. As mentioned, a CEX, on the other hand, would require you to trust the exchange enough to hold your funds.
Additionally, as DEXs typically do not provide fiat-to-crypto trading, DEXs also typically do not require users to undergo the same KYC process that CEXs by law have to provide. For users looking to safeguard their own personal details, this would be a big reason as to why they would choose to trade on a DEX as opposed to a CEX.
It is important to note though, that this is slowly changing. IDEX, the world’s largest decentralized exchange, recently announced that it will be implementing KYC measures to comply with “sanctions and money-laundering laws”. In the announcement, CEO of IDEX Alex Wearn defended the decision as being one that is acknowledging the reality of us being “…in a world where the governance of our service is centralized and the standards against which our service is judged are becoming increasingly clear.”
However, judging from its slowly dwindling number of active users, it seems that DEX users remain adamant about privacy and decentralization. As such, it remains to be seen if DEXs, in general, will follow suit.
As DEXs currently do not support fiat to cryptocurrency trading, the technology currently is more illiquid than what CEXs can provide. Traders looking to liquidate their cryptocurrencies into cash will have to resort to CEXs that support fiat-to-crypto trading.
Additionally, DEXs also run into a classic problem that blockchain technology solutions have to contend with: The Scalability Trilemma. A term coined by Vitalik Buterin (founder of Ethereum), the Scalability Trilemma claims that attempting to optimize any one of the following three blockchain-based platforms will result in a trade-off: decentralization, scalability, and security. A platform true to blockchain principles will require optimization of all 3, and yet usually only 2 can be pursued at any given time. For example, if you want a faster blockchain, you have to be willing to give up some decentralization.
As DEXs require consensus to be achieved in the network before a transaction can be confirmed, the speed in which consensus can be achieved is slower and is a bottleneck that makes DEXs less appetizing to invest in, especially when cryptocurrencies have historically been so volatile in price.
Centralized Exchanges like Binance do not run into the same scalability issues, because they utilize off-chain, centralized servers to conduct transactions between users. Additionally, CEXs like Binance sport an enormous amount of users that regularly use their platform to trade, which in turn makes funds on the platform more liquid as there are more buyers and sellers. As DEXs currently have yet to be adopted on a widespread scale, DEXs do not have the userbase to boast the same levels of liquidity as CEXs. This can be a dealbreaker for some, especially considering how volatile cryptocurrency prices can be.
CEXs generally are easier and more intuitive to use. In a CEX you press buy or sell and things happen in the background to get your order complete. In contrast, multiple steps are typically involved to exchange one cryptocurrency for another in a DEX. The overall experience in a DEX has historically been unintuitive. Also, when it comes to customer support generally in a DEX you will be left on your own when trying to figure things out. CEXs, on the other hand, do provide official customer support staff and safe storage (wallets) for their clients.
However, it’s important to note that these are not all due to intrinsic differences between CEXs and DEXs. Rather, as DEXs are newer entrants into the market, it’s understandable that their user experience generally has lagged behind the more established CEXs. For example, Binance recently launched its own DEX earlier this year, and they made substantive efforts during development to make the user experience be comparable to its widely used CEX.
As more attention is paid toward the security and ideological shortcomings of CEXs, more developmental power will be devoted to advancing and optimizing DEXs.
As the world of crypto matures and develops into the featured ecosystem, the saturation of exchanges and their different functionalities will slowly fade. Though the majority of exchanges are still centralized, there is a general consensus in the crypto community that DEX’s will take on a more prominent role as developers iron out technological kinks. For now, CEXs remain the incumbent despite their shortcomings due to ease of use.
What’s your preferred method of trading? Let us know in the comments below.