When traders want to trade equity and ETFs, many of them use online brokerage firms and centralised exchanges. When it comes to cryptocurrency trading, however, individual investors prefer different mechanisms for trading digital assets. You can understand where and how to trade digital assets by comparing CEX and DEX.
What is CEX?
CEX or centralised exchange is one of the two most popular types of crypto exchanges in the cryptocurrency space these days. Investors generally use centralised exchanges to buy and trade Cryptocurrencies. Some of the CEXs are Binance, Coinbase, and Gemini. Like exchanges and online brokerage firms, many CEXs allow users to deposit funds into accounts, trade flat/crypto and crypto/crypto pairs, trade on margin, and open short positions. Buyers and sellers rely on the middleman, which is the exchange, to conduct transactions and hold their money along with security and monitoring. CEXs generally have order-book systems so clients can enjoy automatic trading.
However, a CEX also has a few downsides. It was the most preferable way for traders to trade crypto in the past, but recently it has shown some vulnerability while encountering security issues with several hacks. Moreover, CEXs are not really anonymous because they store personal data of individual investors on exchanges, and private keys in hot wallets, which can pose a threat to investors’ credentials.
What is DEX?
DEX or decentralised exchange is another type of popular crypto exchanges used today. Unlike CEXs, DEXs allow anonymous transactions while providing minimal information on individual investors. Advanced and experienced crypto traders that prefer to have full control of their funds and also some control of their personal data prefer DEXs. Decentralised exchanges offer greater security as they do not require users to hold their funds in hot wallets and do not have access to the investors’ private keys. As a result, they are not so vulnerable to hackers. Moreover, users can open an account quite easily. Most DEXs do not ask for KYC, which makes the whole process easier.
People interested in purchasing large amounts of Cryptocurrencies or trading ERC20 tokens often find decentralised exchanges more useful. Apart from anonymity and full control over capital, blockchain has revolutionized margin trading. Blockchain has allowed substituting margin trades with the revolutionary Hedge Trade system that enables traders to obtain digital assets for escrow of their digital holdings.
Types of DEXs
Types of DEX by currencies are –
- Currency-centric exchanges: Currency-centric exchanges are developed on top of singular platforms like Ethereum. It is limited to the platform currency it is built on only.
- Currency-neutral exchanges: Currency-neutral exchanges are built to connect different Cryptocurrencies.
DEXs fall into three categories if divided by core functions, such as –
- On-chain order books and settlements: The first generation DEX was entirely blockchain-based. All updates in the order book, whether it is a new order or an adjustment to an existing order, it was bound to be reflected in the state of the blockchain. However, it soon became obvious that protecting the privacy of users is not worth sacrificing liquidity and speed, regardless of how secure the method is. Moreover, this frequent and straight-forward interaction with the blockchain led to zero interoperability with other exchanges and high fees.
- Off-chain order books with the on-chain settlement: to mediate the drawbacks of the first generation DEX, an adjustment was found in trustlessly keeping the order books off-chain. In this approach, trades are still executed on the blockchain, but third-parties called Relayers host the order books. These Relayers are connected through the protocol and can create a solid trading infrastructure by aggregating common liquidity. After an order is submitted to the Relayer by a market maker, a taker fills that order, and only after that, the trade is executed trustlessly. Until then, all funds remain under the complete control of the counterparties.
- Smart contract-managed reserves: Using smart contract-managed reserves on platforms like Kyber is the most comprehensive solution to date of the order matching problem. In this approach, every reserve transaction is managed by smart contracts instead of off-chain matchmakers. The platform itself holds a singular reserve to provide liquidity, whereas additional reserves can be private or public. The contributions by users replenish the former continuously, who are benefitted by sharing in its profits. The latter ones are constituted by individual token holders who offer their crypto to the exchange liquidity pool by setting their own rates.
Advantages of Using DEX
Apart from the features mentioned earlier, there are many benefits of using DEX, such as –
- No central points of failure – There is not a single third-party service on DEX. Traders can trade through the decentralised peer-to-peer networks.
- Lower fees – DEX offers less operation cost. By trading through smart contract execution, traders only have to pay transaction fees for miners.
- Not censorable – Traders can have full control over the use, security, and transfer of funds, and private keys. Regulators or governments cannot pressure them to shut down or censor certain trades.
- Less server downtime – Hosting is distributed throughout the involved nodes.
- No KYC – Since DEXs are not single entities, KYS is not required. So, ultimate privacy and anonymity are maintained. Anyone can participate in trading conveniently. They only need to own a wallet and they can be registered.
- No infrastructure risk – DEXs do not have any infrastructural risk during the execution of trade orders. This feature provides the user with the flexibility to trade anytime without any major issue.
- No theft of banking information – An DEX works through Cryptocurrencies only. So, it is not risky to share banking information here.
As an investor, you should understand that you can trade Cryptocurrencies on different exchanges. You must also recognise the value proposition on different kinds of exchanges since it can have a huge impact on the financial performance of a trader. Although CEXs offer great liquidity, it is better to go for DEXs because it provides greater anonymity for individual investors along with revolutionary hedge trade systems that are not available on centralised exchanges.