After the collapse of the FTX crypto exchange in 2022, which deprived thousands of users of their assets, talk in the crypto market about the imminent victory of decentralized crypto exchanges (DEX) over centralized trading platforms (CEX) has become more frequent.. Increasing regulatory pressure in the US on large platforms in 2023, as it seemed to many, should have accelerated the flow of users from CEX to DEX. However, this did not happen – decentralized crypto exchanges remained a niche product by the beginning of 2024, while centralized platforms recorded an influx of new users. The reason lies in the nuances of how CEX and DEX work and their different target audiences.
Let's take a closer look at the advantages of decentralized and centralized crypto exchanges.
Security and Availability
Security is the first argument that supporters of decentralized crypto exchanges give when explaining their choice. When a user stores their cryptocurrencies in their own wallet and controls their private key, this means that only they have access to these funds. Full control over your own assets is a fundamental principle of cryptocurrencies. Therefore, many crypto enthusiasts see centralized crypto exchanges as a threat to their coins. When a user tops up his balance on a centralized crypto exchange, he transfers coins to the exchange’s wallet and partially loses full control over his coins. As you know, Not your keys, not your bitcoins.
But if you look at the security systems of large crypto exchanges, this level is hardly accessible to the average crypto investor. For example, private keys for accessing the cold wallet of the OKX exchange are encrypted and stored by several employees of the crypto exchange, who are located in different countries, do not use the same type of movement at the same time and do not travel together. The OKX hot wallet system uses a variety of technical solutions: semi-autonomous risk management systems, semi-autonomous multi-signature systems, big data-based risk management systems and other security mechanisms.
On a DEX, users retain control of their assets. They connect wallets to a smart contract, but the coins themselves continue to be stored in the wallets. Users do not have to trust the storage of coins to the exchange. But this does not eliminate the risk of hacking the smart contract itself with which DEX works:
“DEX is also hacked, they also have exploits in their code, and so on,” said Changpeng Zhao, who at that time served as CEO of the world’s largest exchange Binance.
Decentralized platforms also attract lovers of privacy and confidentiality. Traders do not have to go through an identification process to register – unlike centralized exchanges, many of which have made KYC verification mandatory. DEXs generally do not restrict users based on where they live. Traders from different countries can trade freely without having to go through complex verification procedures.
Liquidity
The key factor in choosing a trading platform for traders is its level of liquidity. Liquidity determines how quickly a trader can buy an asset and exit it at an attractive price. The success of investment in assets, be it stocks or cryptocurrencies, largely depends on liquidity.
Centralized and decentralized crypto exchanges take different approaches to the very form of liquidity provision. Generally, centralized exchanges have higher liquidity compared to DEXs. This is not only due to the fact that, thanks to a more intuitive and user-friendly interface, CEX often has a larger user base, which includes both large institutional investors and professional traders, including high-frequency.
“CEXs offer higher liquidity, which is especially important for traders and institutional participants; while DEXs provide users with greater control over assets and the ability to explore new crypto assets, which attracts crypto enthusiasts and users with a high level of technical knowledge,” explains Lennix Lai, Chief Commercial Officer of OKX.
Large CEXs typically employ market makers who provide order book liquidity. Market makers are traders or large institutions that place limit orders, helping to increase market liquidity. Centralized exchanges often use various mechanisms to attract market makers, for example, offering reduced commissions for active trading. And this creates a network effect: the higher the liquidity, the narrower the spread between the purchase and sale price of an asset, and this attracts even more users and increases liquidity.
Liquidity on DEX is structured differently: it depends on the willingness of users themselves to provide their coins to liquidity pools. Typically, in exchange for providing liquidity, users receive a portion of the commissions that traders pay when making trades. Such liquidity pools exist for each individual trading pair. For example, to become a liquidity provider in the ETH/USDT pool, you need to deposit both ETH and USDT into the smart contract. The exchange rate of the pair is set automatically based on supply and demand by the smart contract managing the pool. There are no fiat currency trading pairs on DEX. This also imposes restrictions on liquidity.
The statistics speak for themselves. According to The Block, decentralized crypto exchanges now account for just over 7% of total spot trading volume. The share of DEX reached its maximum level of 14.5% in May 2023, after which it gradually decreased.
This approach to liquidity formation opens up the field for unscrupulous players and manipulators. For example, a group of scammers could create their own ERC-20 token, launch a trading pool on a DEX, actively trade the new coin to create the impression of active trading, and when the pool attracts third-party traders, sell the coins at a favorable price and walk away with a profit, leaving the traders with nothing. with what.
Relations with fiat
Centralized crypto exchanges – not all, but many – allow you to fund deposits using fiat currencies and trade cryptocurrencies against fiat. Decentralized exchanges are cut off from the world of fiat money for technical reasons, because they work on the blockchain and smart contracts.
“The conversation about CEX and DEX misses a key point: both types [of exchanges] perform certain services (cross-currency exchange, custodial custody, sometimes leverage), but CEX also operates as a crypto-fiat gateway, and (what we call) DEX doesn’t do this,” notes Ethereum founder Vitalik Buterin.
User-friendly interface
CEX offers users clearer and simpler interfaces that are easy to learn even for beginners. The user only needs to go through the registration procedure, in some cases, identity verification and replenish the balance of his exchange account. Users can easily create accounts, deposit funds, place market or limit orders, and check their account balances – all from a simple, user-friendly dashboard. The trading process is often simplified and users can have access to a variety of tools, charts and market analysis features.
Different types of orders, copy trading, when a user can copy the trades of a leading trader, trading bots using AI or machine learning – all these services are easily available to users on large centralized crypto exchanges. Many CEXs publish tutorials on how to use their tools.
DEXs work with smart contracts, which implies higher technical literacy of the user. Interaction with DEX requires the ability to interact with smart contracts, connect a wallet, for example, MetaMask to the desired smart contract, and most importantly, be responsible for every error that can lead to loss of funds if configured incorrectly.
“There are still a lot of people who are much more comfortable using an email and password. If you ask my parents’ generation, they would have preferred [email address and password] instead of a USB drive and encrypted backup of private keys,” Changpeng Zhao sneered, explaining his belief that centralized crypto exchanges will not disappear even if decentralized ones sites will be able to grow.
The interface functionality on a DEX is also usually inferior to the capabilities of a centralized crypto exchange.
Trading commissions
CEX and DEX trading fees vary depending on the specific platform. There is no clear advantage in commissions between CEX or DEX. Typically, CEXs charge trading fees as a percentage of the transaction value, and these fees can vary depending on factors such as trading volume or instrument type. Large CEXs attract traders with multi-level loyalty programs, where traders with high trading volumes are offered up to zero trading commissions. Many CEXs offer discounts on trading commissions for those users who hold internal crypto exchange tokens on their balance sheet. CEXs also offer discounted fees to market makers (those who provide liquidity to the order book).
DEXs have a similar approach, except that they also charge fees associated with the use of smart contracts on the blockchain. These fees may include gas fees.
For example, if you look at the commission policy of the largest DEX Uniswap, it differs little from the largest CEX. But since Uniswap runs on the Ethereum blockchain, Uniswap users may face high gas fees during network congestion.
Listing
A wide selection of crypto assets is another key factor in choosing a trading platform. This aspect varies among the CEXs themselves: there are crypto exchanges that prefer a narrow range of time-tested cryptocurrencies, there are trading platforms that have included hundreds of cryptocurrencies in their listing. For example, the US-registered crypto exchange Gemini has listed 80 cryptocurrencies, while the OKX crypto exchange, the second largest in the world by trading volume, offers more than 300 cryptocurrencies and about 600 trading pairs in the spot and futures markets. Some CEXs offer fiat-crypto trading pairs, allowing users to trade cryptocurrencies directly against fiat currencies.
Generally, centralized exchanges have certain listing criteria, which include regulatory compliance, security audits, and analysis of the project's tokenomics.
“If we just take and float all existing tokens, it will help us make more money, but it will destroy the market. OKX is not trying to be the best in terms of the number of coins available on the exchange. Spam in the form of listing requests in my X profile does not work,” this is how Star Xu, head of the OKX exchange, recently explained the refusal to include some tokens in the listing.
CEX, if the platform values its reputation, conducts a thorough analysis of cryptocurrencies before including them in the listing. This helps weed out junk projects and, to some extent, protects crypto exchange users from possible losses.. New projects with their own tokens are rarely immediately listed on major CEXs. At best, they manage to achieve placement on the launchpads of crypto exchanges – special platforms for the primary sale of tokens.
DEX's approach is exactly the opposite: these marketplaces prefer an open listing policy. Almost any project can list its token on a decentralized platform. The main requirement of a DEX is usually that the project itself will have to fill the liquidity pool. This approach has both pros and cons. On the one hand, on the DEX the user will find a wider selection of tokens, and this allows you to purchase an asset at the initial stage of project development and receive maximum profitability. Thus, Uniswap V3 features almost 1,100 cryptocurrencies and more than 2,300 trading pairs. On the other hand, this carries the risk of stumbling upon a junk token.
Synergy between DEX and CEX
Given the limited user experience and liquidity inferior to centralized crypto exchanges, decentralized platforms are unlikely to become leaders in trading volume in the cryptocurrency market in the near future. But their unique advantages, such as extensive listing and increased privacy, attract users.
Instead of competition, large CEXs choose to incorporate decentralized marketplaces into their ecosystems to provide users with freedom of choice and the ability to benefit from all types of trading within one ecosystem.
Lennix Lai of OKX believes that both types of trading platforms complement each other: “I wouldn’t say that CEX wins over DEX or vice versa.”. They both serve the needs of different user groups and both provide value to the development of the cryptocurrency ecosystem.. CEX and DEX should complement each other, and in fact the gap between them is getting smaller. Technologies and innovations that arise on one side are often applied on the other.”
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