CEX vs DEX

CEX stands for Centralized Exchange and DEX stands for Decentralized Exchange. Since Ethereum was established, the creation of dapps (decentralized apps) where possible, and with that, decentralized exchanges were found. Decentralized exchange is a Peer-to-Peer exchange or to be specific in many cases a Peer-to-Contract exchange, where no central market makers are required. Most digital exchanges have automated market markers that are governed by smart contracts. DEXs provide the key elements of decentralized finance - privacy, anonymity, and security. However, most of the trades of cryptocurrencies are executed on CEX. Some of the most popular CEXs are Binance, Coinbase, and Bitfinex. Popular DEXs are for example Sushiswap, Uniswap, or Pankaceswap. This article will show you the differences between DEX and CEX and the advantages and disadvantages of each.

Key takeaways

DEX stands for Decentralized Exchange and is a part of the world of Decentralized Finance (DeFi)
CEX stands for Centralized or traditional Exchange and is a part of the world of Decentralized Finance (DeFi)
Many of the most popular DEXs use smart contracts and Liquidity pools to provide liquidity
DEXs are more complicated to use for beginners but provide more control over their token
Many DEXs have a higher risk of high slippage and impermantent loss

Differences between centralized and decentralized Exchanges

DEXs are part of the world of decentralized finance (Defi). They work through a Peer-to-Peer (P2P) or in the case of AMMs through a Peer-to-Contract network without a central authority. CEXs are part of the centralized world of finance (Cefi), where a central governed exchange coordinates interactions.

DEX -> Defi

CEX -> Cefi

CEXs have a broader client base and therefore a higher trading volume which results in higher liquidity. They are also custodial, which means that they store users' funds and their wallets. That makes CEX a bigger target for hackers that try to hack into users' wallets. Therefore it makes the trader very dependent on the security standards of the CEX because they are not the owner of their keys. In the worst case, they lose access to their tokens if they don't transfer them to their wallet. On the other side, the trader has less effort to manage their accounts. However, because many DEX are run through smart contracts, traders are dependent on the code of the smart contract is bug-free. There is a potential risk that the code is not free from bugs so hackers could take advantage of it. On DEX, orders are executed mostly on-chain, which makes them generally spoken transparent. They provide privacy, anonymity, and security. DEX don't operate with fiat money so they don't require bank details. Generally spoken DEXs are free of regulatory impact. That means, that there are no potential limits due to regulatory scrutiny, but they are also free from regulatory scrutiny. You can call them the Wild West of Finance. DEXs can face high gas fees whereas on CEX liquidity providers pay themselves for creating a market, mostly through the spread. Liquidity is provided better on a CEX because of the higher trading volume. There are different variations of DEXs to provide liquidity and enable a market but it still has a higher risk of slippage than a widely used CEX. For beginners, a DEX can be more complicated to use than a CEX. Therefore DEXs provide more control.

Title	DEX	CEX
Potential Liquidity issues (especially for less popular Tokens)	Yes	(No)
Exchange is govern by transparent smart contracts (AMM)	Yes	No
Users have full control over their funds	No	Yes
Direct transactions between users (or smart contracts)	Yes	No
Potential limits due to regulatory scrutiny	No	Yes
Regulatory assurance	No	Yes
Transaction fees	High (because of gas)	High (because of middleman)
Robust liquidity	No	Yes
Complexity	(High)	Low
Control	High	Low
Security risk (target for hacker)	Yes (potentially due to bugs in smart contract)	Yes
High slippage	More likely	Less likely

Functionality of a DEX

In a CEX, the market maker is matching the buyers orders with the sellers orders. The goal here for the market maker is to provide liquidity so tokens can be traded without complication. To provide liquidity, market makers buy and sell tokens from their own accounts with the goal of making profits from the trades. Often this profit is made from the spread, which is the difference between the highest buying offer and the lowest selling offer. A DEX has three main functionalities to provide liquidity from which Automated Market Maker (AMM) is the most commonly used.

Automated Market Maker
Order Book DEX
DEX Aggregators/ Hybrid DEX

Automated Market Maker (AMM)

The problem Blockchains like Ethereum are facing is, that they can't handle large on-chain order book transactions, because yet they are not efficient enough to handle the high order volume. Future solutions could use sidechains or layer-two solutions which for the moment are not efficient enough. However, there are Blockchains that can handle on-chain order books like the Binance DEX built on the BNB Chain, or the Project Serum, built on the Solana Blockchain. However, most of the tokens are on the Ethereum chain, and without using a cross-chain bridge, you can't trade them directly on other chains. An AMM doesn't match a selling order with a buying order directly, but instead, it uses Liquidity Pools (LPs), from which buyers can get their tokens.

LPs enable on-chain trading without the need for an order book. With the use of LPs, traders don't have a direct counterparty they are trading on and therefore they can get in and out of positions on token pairs that likely would be illiquid on order book exchanges. LPs are funds deposited into a smart contract by liquidity providers. Because of that, AMMs allow a Peer-to-Contract trading. The buyer doesn't need a direct counterparty who sells, instead, he trades against the Liquidity Pool. All he needs is sufficient liquidity in the pool.

Order Book DEX

As mentioned before, there are some Blockchains like the BNB chain or the Solana chain, that can handle on-chain order books. However, because most crypto assets are built on the Ethereum Blockchain, it is not possible without any further trade assets cross-chain. Nevertheless, Order Book DEX can vary in efficiency when facing low liquidity markets or high volume trades which can cause high slippage. There are two types of Order Book DEX: On-chain Order Book DEX and Off-chain Order Book DEX. On-chain Order Book DEX provides full transparency because all trades happen on the blockchain and are traceable and verifiable publicly. This often comes with the costs of higher transaction fees and slower transaction speed.

Off-Chain Order Book DEX handles most of the trading activity off-chain and only settles the final trades on the chain. This comes with the risk of centralization because most of the trading activity happens off-chain and it cannot be ensured, that they are not controlled by. a single entity or a group of people.

DEX Aggregators/ Hybrid DEX

A DEX Aggregator - also called Hybrid DEX - combines the benefits of AMMs and Order Book DEXs. It checks out multiple trading venues and offers the best possible trading price. While some exchanges offer better prices with higher risk of slippage, others, offer lower slippage risk with higher prices. DEX Aggregators can offer smart order routers that identifies the best overall exchange or liquidity source to make a trade with. They can also slippage protection and price order protection.

Title	Order Book DEX	AMM DEX	DEX Aggregators
Arbitrage Opportunity	Arbitrage opportunity of price differences between two Order Book DEXs or between CEX and DEX	High gas fees can neutralize arbitrage profits	Complicated. Requires more sophisticated tool
Order Latency	Fast	Slow	Fast
Impermanent Loss	No	High	Low
Market Manipulation	High	Low	Low
Transaction Cost	Low	High	Low
Liquidity	High Liquidity requirements. Functioning strongly depends on sufficient available markets	Enhanced liquidity due to liquidity pools everyone can participate	Improved liquidity due to the combination of both systems
Complexity	Familiar to CEX	Low	Complex for newcomers
Slippage	Low	High	Balanced
Price Discovery	Fast/ Real-time	Slow	Fast/ Real-time