DEX is the core part of DeFi. It is used to facilitate asset trading and liquidity in the entire ecosystem. For most users, the first concept they need to deal with is DEX when they enter the world of DeFi. I assume you have tried Uniswap (the largest DEX on ETH) before?
The Meaning of DEX
Short for decentralized exchange, DEX is a blockchain-based exchange. Instead of storing uses’ assets and personal data in servers, it only functions as an infrastructure to match sellers with buyers based on their needs for selling and buying digital assets. With the support of matching engines, this kind of trading occurs directly between participants (peer to peer).
Advantages of DEXs
A centralized exchange (CEX) stores and controls its clients’ assets while a DEX won’t do so.
In a DEX, assets are decentralized by users or exchange software. By doing so, there won’t be a single entity that takes possession of all cryptocurrencies in an exchange. Thus, loss can be reduced significantly.
Two Major Features of the DEX:
You only need a public key to use CEX. Besides, some founders of CEXs claim that they are only responsible for developing open source software, so they can avoid issues related to KYC and AML.
Over the past 10 years, CEXs such as Mt. Gox and Coincheck have witnessed more than 30 hacker attacks. The attempt to break into CEXs for stealing assets has never stopped. Every day there are hackers who try to find vulnerabilities on CEX via different approaches. Since DEXs are distributed across a wide network of computers, it is very difficult to attack them. When there is no single access point and failure point, trading in DEX is safer.
Drawbacks of the DEX
1. Low Liquidity and Shallow Market Depth
DEX is still less popular than CEX. Thus, DEXs have relative fewer clients; lower liquidity and trading volume.
2. Lack of Professional Trading Setting
It is not so convenient for DEX traders to use the platform due to the lack of senior trading options. In a decentralized environment, it is rather difficult to carry out algorithmic trading and high-frequency trading.
To use a DEX, you need to connect to a DApp and even install an offline DEX client. To complete trading, you may need to equip your computer with an independent node and remain online.
Differences between DEXs and CEXs
Differences between DEXs and CEXs are as follows:
1. Different Controls Over Your Funds
In a CEX, the platform takes charge of users’ assets. Users need to transfer their funds to CEX wallets. CEX’s asset custody function is similar to that of a bank. Users save their money in the bank and the bank offers them an account in which their financial status is recorded. In other words, the bank has full control over its clients’ money.
But in a DEX, users are in total control of their assets. DEX doesn’t offer assets custody service, so it cannot control or transfer users’ funds.
2. Different Security Levels of Clients’ Funds
All users’ assets are stored in CEX’s wallets, which will likely attract hackers who come for the heaps of funds. Not to mention the cases where exchanges steal users’ money or even pull the rug.
In a CEX, risks mainly come from hacker attacks and absconding. Once these things happen, almost all users will suffer. By contrast, in a DEX, the risks mainly lie in improper handling of wallets’ private keys, so the leaking of one’s private key does no harm to others’ assets. Users’ assets are under complete separate management.
3. Different Transparency in Trading
Transaction between CEX users is debited by the platform and transaction information is only recorded on CEX’s internal account book instead of on an unchangeable blockchain. So CEX trade is also called off-chain trade. Since its transaction process is not quite transparent, it’s easy for a hostile CEX platform to change trade records.
However, DEX users complete their trade in blockchain. In the process, miners pack transaction data and broadcast to the network, so DEX trade is given another name — on-chain trade. Once trading info is sent to the blockchain, it becomes unchangeable and available to the public. In other words, DEX trade info is safer and more transparent.
4. Different Trade Experience
Since CEX trade data is not sent to the blockchain, once a sell order and a buy order is matched, the trade process can be very fast. Besides, the platform is easy to operate, accessible, and provides high supply and demand that can be paired with, which attracts more users, and thus results in better market depth. This further increases its trade speed.
Since in a DEX platform, trade data need to be issued on blockchain and trade information need to be verified through block producers’ packing and broadcasting, the whole process takes more time. DEX is relatively more difficult to operate, and thus a bit more inaccessible. When it comes to inter-blockchain transactions of assets like trade between Bitcoin and Ethereum, more complex inter-chain technologies are needed. Since many DEXs don’t have relatively technical support, they cannot offer as many trades as their centralized counterparts.
In a word, CEX transaction is faster and more accessible and more user-friendly than DEX.