Exchanges: Centralized vs Decentralized
In this post we are going to explore the two main types of exchanges: Centralized Exchange (CEX) and Decentralized Exchange (DEX). At the surface, they provide the same base functionality, the ability to turn one crypto into another. How they pull it off, and all the factors around it, are quite different though. I hope this post helps you better understand what they have to offer, and their drawbacks.
For the usual disclosure, I am not a financial advisor, I don’t even work in finance at all. My day job is as a telecommunications software engineer. Treat everything you read here as some educational resources and not financial advise. Some of the links you find on here will also be affiliate links, so using them will benefit the both of us.
Centralized Exchanges (CEX)
We’ll start off by talking about what a Centralized Exchange (CEX) is. These would be the big exchanges such as Coinbase, Binance, and Newton. These exchanges are run by actual companies, and have actual staff working for them. They are also required to stake up their own liquidity, generally by raising money like any other company, in order to be able to cover customer’s withdrawing from the exchange.
Some of them like Binance will offer quite a few cryptos (although not all of them), some will offer a smaller subset like Coinbase does. They all also have different trading options and screens, some will offer more advanced features like limit orders and futures trading, while others stick to a more basic interface for simple transactions.
While generally safe, centralized exchanges have been known to fail miserably, or have the owner run off and fake their own death. A lot of them have a fair bit of backing of corporate money, and seem to be pretty stable, but even Binance has had moments where they have locked wallets and trading. Everything in crypto is a risk, it’s all about mitigating it to as low a level as possible.
Always keep in mind when dealing with centralized exchanges, you do not control the keys to your crypto. All of your funds are held in custody by the exchange in their wallets until you decide to withdraw it. One big phrase that gets thrown around a lot is “not your keys, not your crypto”. I’d highly recommend any crypto that you are not planning to trade in the near future, to move off the exchange and into your own wallet.
Decentralized Exchanges (DEX)
Next, we are going to talk about Decentralized Exchanges (DEX). These are exchanges such as Uniswap. These, unlike their centralized brothers, have no backing organization, and exist solely on the blockchain, generally using smart contracts.
I won’t get too into the weeds on this part, as I plan to cover liquidity providing in a later post. Instead of the organization that runs the exchange staking up the funds needed to provide liquidity, these are generally provided by the community by staking their crypto into smart contracts for a piece of the fees that are generated by the exchange.
Decentralized exchanges also generally tend to list a lot more available cryptos than a centralized one, because it’s all community managed, and anyone can add smart contracts in. This is why, when using a DEX, it’s very important to ensure you are Doing Your Own Research, and making sure you know what you are getting into.
As far as security, a decentralized exchange should be pretty secure, at least as far as exchanging cryptos. The only custodian of your funds would be the smart contract, and they tend to be pretty good, but not fail-proof. There have been hacks against smart contracts that have drained them of a lot of cryptos, so it does not come without it’s own risk.
I would say the risk is more for the people that are storing their crypto in a liquidity pool, versus someone just doing a quick swap, but the risk is not zero. Decentralized exchanges do have the added benefit of working out of your wallet, something like MetaMask, so you maintain control of your private keys. Unless you send your crypto to a liquidity pool of course.
Something that is common to both types of exchange is fees. On CEX’s Binance you have trading and withdraw fees to consider. On DEX’s, you generally only have to worry about the network fee, but where a lot of them are trading ERC 20 tokens on the Ethereum (ETH) network, gas fees can be pretty high. Part of doing your own research, is checking the fees that may be incurred.
I hope this article helps clear up the difference between Centralized and Decentralized Exchanges, and helps you understand the pros and cons of each. Personally, I use both, and it’s all about deciding what is best for what you want to accomplish, and weigh out the risks involved.
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