If you are looking for a crypto exchange to start your crypto journo, there’s one thing you need to know before you choose. There are two types of exchanges: Centralised (CEX) and decentralised (DEX).
They offer different ways to buy and sell crypto, so let’s dissect how they operate so you can decide which is the better option for what you want to achieve with your investment goals.
What is a centralised crypto exchange (CEX)?
A centralised crypto exchange (CEX) is a platform that has a central authority, usually a company that runs it and operates as a middleman. This central authority facilitates the buying, selling, and trading of cryptocurrencies between users. It also can hold the users’ funds in accounts on the exchange, and can execute trades on their users’ behalf.
CEXs typically offer high liquidity, meaning they have many cryptocurrencies on hand ready for people to trade.This means that trades can be executed quickly and efficiently. An example is CoinJar.
Reputable CEXs in the UK are registered with the Financial Conduct Authority and so have to follow rules and regulations around how they operate and how they market their services.
What is a decentralised crypto exchange (DEX)?
A decentralised crypto exchange (DEX) is a peer-to-peer marketplace with no central authority. Users can trade cryptocurrencies directly with each other without the need for an intermediary.
Users hold their own cryptocurrencies in their private wallets. The exchange doesn’t hold the crypto for them. These exchanges are not registered with the FCA, so they don’t require a lot of personal information to be handed over to use them.
Uniswap is an example of a DEX.
So let’s look at the pros and cons of Cexs vs Dexs.
Searches for security
Users often use the word “security” when searching for or researching crypto assets. While no crypto exchange can ensure your assets are fully secure, there are some ways to assess the protection measures used by the various platforms.
The importance of protection cannot be overstated. Crypto platform protection should be on the radar of anyone aiming to enter cryptocurrency platforms. It is wise to actively seek information to ensure the protection of your digital assets, and which platforms prioritise protection measures.
Protection – centralised exchanges
Asher Tan, CEO of CoinJar, says that while protection is more robust than it ever was, hackers are becoming increasingly sophisticated. So CoinJar stores the majority of customer crypto offline in multi-sig cold wallets (not connected to the internet) with a small percentage being stored in hot wallets which allow for quick withdrawals.
“A multi-sig wallet requires multiple signatures (or approvals) to authorise a transaction. This means that no single person has the power to move large amounts of funds alone. Instead, multiple team members need to agree and digitally sign off on any transaction. This adds a significant layer of protection, as it’s much harder for a hacker to compromise multiple independent systems and obtain the required signatures.
“This approach offers further protection than a single-signature wallet, where one compromised key can lead to the loss of all funds. With multi-sig, even if one key or device is compromised, the funds remain secure.”
Protection – decentralised exchanges
A DEX, if hacked, won’t have all of the crypto in one place. This is thanks to the distributed nature of the platform. That is, there is not one central place where the funds are stored. However, users who have provided liquidity, could lose everything they placed in liquidity pools.
Also, hackers have been known to trick DEX users into signing transactions that empty their wallet.
There are other risks. Users are responsible for their own crypto and crypto wallets, so if they lose their passwords or make a mistake, no one can help them get those funds back. Whereas CEXs tend to have customer support if something goes wrong.
Fees
There are different types of fees on both CEXs and DEXs.
CEX fees
Trading Fees: These are the most common fees on CEXs. They’re typically charged as a percentage of your trade volume. For example, a CEX might charge 0.1% to 2% for every trade you make. Fees can sometimes be lowered based on trading volume or if you hold a certain amount of the exchange’s native token.
Deposit/Withdrawal Fees: These fees vary greatly depending on the CEX and the cryptocurrency you’re depositing or withdrawing. For example, depositing fiat currency like GBP or USD might have a fixed fee, or be free, while withdrawing Bitcoin might incur a network fee based on current blockchain congestion.
Here is an example. If you buy £1,000 of Ethereum (ETH) on a centralised exchange, you might pay a 0.1% trading fee (£1). Additionally, if you withdraw your ETH to an external wallet, you might pay a network fee as well.
DEX fees
Trading Fees: DEXs usually have lower trading fees than CEXs, unless the blockchain is busy. Then the fees can get uncompetitive. Gas fees on the Ethereum network may hit £400 or more. Some DEXs charge a flat fee per trade, regardless of the amount.
Network Fees (Gas): These are fees paid to the blockchain to process your transaction. The amount of gas required varies based on the complexity of the transaction and the current congestion of the network. For example, swapping tokens on Uniswap (an Ethereum-based DEX) costs you gas fees, which jump during high network activity where there is more demand.
Here is an example. If you swap £1,000 of ETH for another token on Uniswap, you might pay a 0.3% trading fee (£3) plus £10 in gas fees, depending on the current Ethereum network congestion. However if congestion is high, you could be charged hundreds of Pounds in gas fees for a single transaction.
CEX vs DEX: Liquidity
Liquidity refers to how easily an asset can be bought or sold without causing a significant change in its price. In cryptocurrency exchanges, high liquidity means there are many buyers and sellers, allowing users to quickly execute trades at fair market prices.
CEX liquidity: The deep pool
Centralised exchanges are like bustling marketplaces. They have a large user base and substantial trading volumes. This means there’s always someone ready to take the other side of the trade.
Buy or sell orders are filled almost instantly. The difference between the buy and sell price (the spread) is usually small, meaning you get a better deal.
Users can execute large trades without drastically impacting the market price.
Say if a crypto user wanted to buy 1 Bitcoin on CoinJar. The high liquidity means there are enough sellers willing to part with their BTC at the current market price, allowing you to complete your purchase quickly and efficiently.
DEX Liquidity: The growing pond
Decentralised exchanges like Uniswap and SushiSwap operate differently. They rely on liquidity pools, where users deposit their crypto assets to facilitate trades. While DEXs are gaining popularity, their liquidity can vary.
Popular tokens like Ethereum (ETH) or stablecoins usually have decent liquidity. However, lesser-known or newly listed tokens may have limited liquidity, meaning fewer people are buying or selling them.
Also there is potential for “slippage”. Slippage occurs when the price of an asset changes before your trade is executed due to low liquidity. This means you may end up paying more or receiving less than you expected.
With lower liquidity, it might take longer to find a match for an order.
An example: Say a user wants to trade a rather unknown altcoin on a DEX. Due to the lower liquidity, there might not be enough buyers or sellers immediately available, potentially leading to slippage or a delayed trade execution.
CEXs generally excel at liquidity, making them ideal for trading popular cryptocurrencies or executing large orders.
DEXs are improving in liquidity, especially for popular tokens, but aren’t ideal for people who like to buy less well-known cryptocurrencies.
CEX vs DEX: Usability
CEXs are a preferred option for new users. CEXs usually have user-friendly interfaces, making them more accessible for beginners. Offer a wide range of features like margin trading, staking, and lending.
DEXs can have steeper learning curves, especially for those new to crypto. Interfaces might be less intuitive, but experienced users may appreciate DEXs more than CEXs.
Regulation and compliance
Because reputable CEXs register with the FCA, they are required to follow FCA rules. This means that people signing up are subject to Know Your Customer (KYC) and Anti-Money Laundering (AML) regulations, requiring users to verify their identity. This can be a deterrent for privacy-conscious individuals.
DEXs generally operate without KYC/AML requirements, offering more anonymity. However, this landscape is evolving, and some DEXs may start implementing regulatory measures.
Control and ownership
When using a CEX, users relinquish control of their funds to the exchange. While this can be convenient, it also means that if the exchange is hacked or goes bankrupt, like the notorious collapse of the FTX exchange, users can lose all of their funds, or have to wait years to get them back.
When using a DEX, users retain full control over their assets, giving them more autonomy. However, this also means greater responsibility for protection of assets and fund management. If users make a mistake, it is unlikely that they will get their money back.
Which exchange should you choose?
The most suitable exchange for you depends on your priorities, such as security measures, fee/charges, structures, and personal risk tolerance.
If you value convenience, user-friendly interfaces, a wide range of assets, and high liquidity, a centralised exchange might be a good fit.
If you prioritise privacy, control over your funds, and are comfortable with a potentially steeper learning curve, a decentralised exchange could be an alternative choice.
Availability of tokens
A primary motivation for using DEXs is to gain early access to tokens not yet listed on CEXs. This is driven by the expectation that a CEX listing will trigger substantial price appreciation, creating a potential for investment gain prior to the listing event.
Conclusion: Comparison of CEX and DEX
In conclusion, the CEX vs DEX debate highlights the fundamental differences between a centralised market and a decentralised crypto exchange. The choice between a centralised versus decentralised platform, or centralised vs decentralised, depends on individual preferences and priorities.
Centralised exchanges offer user-friendly interfaces, high liquidity, and a wider range of services, making them a popular choice for beginners and high-volume traders. However, they require users to relinquish control of their assets and trust the exchange’s protection measures.
On the other hand, decentralised exchanges prioritise user autonomy and protection through decentralised exchanges and self-custody of assets. While they offer greater control, they may have lower liquidity and a steeper learning curve for new users.
Understanding the key distinctions between centralisation versus decentralisation is crucial when deciding which type of exchange aligns with your trading style and values. By exploring how centralised exchanges work and how decentralised exchanges work, you can make an informed decision and navigate the world of decentralised and centralised crypto trading with confidence.
Remember, thorough research is important before selecting any exchange. Consider factors like protection reputation, fees, available assets, and user reviews to make an informed decision. After that, happy crypto trading!
Standard Risk Statement
The above article is not to be read as investment, legal or tax advice and it takes no account of particular personal or market circumstances; all readers should seek independent investment advice before investing in cryptocurrencies. The article is provided for general information and educational purposes only, no responsibility or liability is accepted for any errors of fact or omission expressed therein. Past performance is not a reliable indicator of future results.
UK residents are required (in accordance with local legislation) to complete an appropriateness assessment to show they understand the risks associated with what crypto/investment they are about to buy and enabling CoinJar to categorize them as an investor. New customers are also required under local regulations to wait 24-hours as a “cooling off” period (from account creation), before their account is active (i.e. to deposit, trade, withdraw etc.).
Cryptocurrency is currently not regulated in the UK. It’s vital to understand that once your money is in the crypto ecosystem, there are no rules to protect it, unlike with regular investments. Using a uk crypto exchange can offer some level of reassurance, as many adhere to industry best practices, but this does not replace formal regulation.You should not expect to be protected if something goes wrong. So, if you make any crypto-related investments, you’re unlikely to have recourse to the Financial Services Compensation Scheme (FSCS) or the Financial Ombudsman Service (FOS) if something goes wrong.
Remember:
Don’t invest unless you’re prepared to lose all the money you invest. This is a high‑risk investment and you should not expect to be protected if something goes wrong. Take 2 mins to learn more.
https://www.coinjar.com/uk/risk-summary
Stablecoins carry the following risks:
- Depegging events: Depegging events may occur with stablecoins that fail to maintain adequate controls and risk mitigants. A depegging event is when the value of the stablecoin no longer matches the value of the underlying asset. This could result in a loss of some or all of your investment.
- Counterparty risk: Counterparty risk arises when an asset is backed by collateral, involving a third party maintaining the collateral, which introduces risk if the party becomes insolvent or fails to maintain it.
- Redemption risk: Redemption risk refers to the possibility that an asset’s ability to be redeemed for underlying collateral may not be as anticipated during market fluctuations or operational issues.
- Collateral risk: Collateral risk refers to the possibility of the collateral’s value declining or becoming volatile, potentially impacting the asset’s stability, particularly when it is another crypto-asset.
- Exchange rate fluctuations: Stablecoins, often denominated in US Dollars, expose investors to fluctuations in the USD:GBP exchange rate.
- Algorithmic risk: Algorithm risk refers to the possibility of an asset’s stability being compromised due to unexpected failure or behaviour of the underlying algorithm, potentially leading to loss of value.