How Crypto Exchanges Work? CEX vs. DEX

by | Jun 10, 2021

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When it comes to participating or investing in crypto, the first step always starts with an exchange. A crypto exchange can be defined as a marketplace for trading cryptocurrencies in exchange for other cryptocurrencies or fiat money. A crypto exchange is a platform for sellers and buyers to trade various digital currencies as per the market price at any given moment.

When it comes to talking about crypto exchanges, I’m sure some of the well-known exchanges come to your mind like Binance, WazirX, Coinbase, or Uniswap. However, not all crypto exchanges work in a similar way. If we talk about types of exchanges – there are two distinct categories of exchanges:

  1. Centralized Exchanges (CEX)
  2. Decentralized Exchanges (DEX)

Before we get into the fundamental differences between CEX and DEX, let’s take a step back and shed some light on the history of crypto trading and exchanges.

History of Crypto Exchanges

When we talk about the history of crypto, we don’t need to go back farther into the past. It all started only a decade back when Satoshi Nakamato mined the genesis block of Bitcoin blockchain in the year 2009. To be precise, the history of crypto is being made as we talk.

To talk about trading, the first-ever Bitcoin transaction was made by Satoshi to Hall Finney just a week after the first block was mined. Just a year later, the first Bitcoin exchange Mt. Gox opened its door and Bitcoin started trading at a price of $0.0008. Soon, a flurry of crypto exchanges came to prominence considering the demand for Bitcoin trading. In 2012, Coinbase and Bitfinex were founded, Okex and BitMAX were set up in 2014, and finally Binance came into existence in 2017. 

Today, Binance is the world’s biggest crypto exchange and allows trading of more than 500 cryptocurrencies. However, all the exchanges listed above including Binance fall under the category of centralized exchanges. So what constitutes an exchange to be centralized or decentralized? Let’s find out.

What are CEXs?

A CEX or centralized exchange such as Binance, Coinbase or Kraken is a for-profit company. They have their own order book where a list of orders that presents different offers from buyers and sellers for a specific cryptocurrency. As they’re for-profit incorporated companies, they abide by the regulatory requirements of nations and require KYC (Know-your-customer) verification from their users.

Furthermore, the centralized exchanges follow a custodial model for safeguarding the users’ crypto assets. Meaning the CEX are responsible for safeguarding your funds and don’t allow access to private keys. Therefore, it’s advisable to trade and store your crypto assets only on trustable crypto exchanges as they’re responsible for the safety of your funds. 

Worth Reading: Top 10 Crypto Exchanges

Centralized exchanges usually have a fixed trading fee that goes to market makers. Market makers are basically liquidity providers that quote both a buy and a sell price in a tradable asset held in inventory, hoping to make a profit on the bid–ask spread, or turn. For a centralized exchange, the company itself acts as a market maker to turn profits through users’ trade.

Additionally, centralized exchanges also allow users to convert their fiat money to crypto assets by using their credit/debit card or making a wire transfer. The exchange usually charges a high fee for such transactions.

What are DEXs?

From the users point of view, a decentralized exchange offers almost similar functionality as that of a centralized exchange. However, there’s a fundamental difference behind the working of a decentralized exchange. DEXs like Uniswap or 1inch works on the principal of AMM (Automated Market Maker) – a new technology that does not rely on the traditional interaction of buyers and sellers and works in a decentralized manner.

The fundamentals of a decentralized exchange resonate with the core ethos of decentralization without any single entity controlling the system, and allowing everyone to participate and build new solutions. For users to trade on a decentralized exchange, they can keep their identity anonymous and don’t need to submit KYC details.

As all the trading activity on DExs are written on blockchain networks (on-chain transactions), the trading fee can be higher than CEXs. Also, transaction fees on DEXs can be unpredictable depending upon the network congestion. However, the decentralized exchange follows a non-custodial model, meaning users are in control of their funds at all times. You don’t need to trust the exchange to safeguard your funds.

However, unlike CEXs, a decentralized exchange doesn’t offer users to convert their fiat money to crypto assets. One has to use another service or a fiat on-ramp solution to convert their funds into crypto assets.

CEX vs. DEX

FeatureCEXDEX
Fiat CurrencyAllowsDoesn’t Allow
Order BookMarket Makers & TakersAutomated Market Maker
FundsCustodial ModelNon-Custodial Model
User IdentityKYC VerificationAnonymous
FeePredictable and lowUnpredictable and high
TransactionsOff-ChainOn-Chain
NatureCentralizedDecentralized

Conclusion

In this blog post, we understood the history of crypto exchanges and fundamental difference between CEX and DEX. In essence, if you’re a newcomer to crypto ecosystem, we’d recommend you to sign up on a centralized exchange as they have easier to understand user-interface and availability of converting your fiat currency to cryptocurrency. Once you’re familiar with the managing your private wallet such as MetaMask, that’s the time to get yourself acquainted with a decentralized exchange such as Uniswap.

In the next blog, we’ll delve deeper to understand how market makers works and why AMMs (Automated Market Makers) are revolutionary?

Head of Content Marketing @ HyperLinq. His love for Chai and mountains precedes everything. Often wonders about things like, "why $1 earned through leverage feels 100x better than $1 earned selling your time?"
Head of Content Marketing @ HyperLinq. His love for Chai and mountains precedes everything. Often wonders about things like, "why $1 earned through leverage feels 100x better than $1 earned selling your time?"

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