There are 4 main ways to buy and sell cryptocurrencies, each with pros and cons. Centralized exchanges (CEX) process the largest amount of cryptocurrency volumes. According to Coingecko, Decentralized exchanges (DEX) volume is just about 5% of total trading volumes. The largest CEX, Binance, has about $14b of 24-hour volume, while the largest DEX, Uniswap, has about $1.6b of 24-hour volume.
For this memo, we will focus on the 2 that are most commonly used: CEX and DEX, and break down the main differences and considerations while using either of them.
- Centralized exchanges (CEX): These are similar to the stock trading platforms that one might use to buy and sell stocks of companies (e.g. Interactive Brokers, TD Ameritrade). They are commonly the gateway into cryptocurrency because of their fiat-to-crypto capability and easy-to-understand (or familiar) user interface. They can be further categorized into spot or derivative exchanges. Examples are Binance, Coinbase, and FTX.
- Decentralized exchanges (DEX): Blockchain underlying technology that enables DEXs. They are either order-book or automated market makers. These are non-custodial exchanges whereby the user connects directly to the platforms using a crypto wallet (e.g. Metamask) to access wallet-to-wallet trading. The benefit of using DEXs over CEXs is the greater anonymity and the ability to keep ownership of funds due to self-custodial. Examples are Uniswap, dYdX, and Balancer.
- Instant Exchange: Considered a sub-set of centralized exchanges and commonly a use-case available on centralized exchanges. A user can buy/sell crypto immediately without waiting for their orders to be filled. A parallel to the traditional finance world is money changers. Examples are Changelly, LetsExchange, and Binance “Convert”.
- Peer-to-peer: As the name suggests, trading directly with specific individuals. This can be facilitated via online platforms/marketplaces or informally through chat groups (e.g. Telegram), where price negotiation is possible. An important consideration to make is how reliable the other party is. Examples are LocalBitcoins and Paxful.
The value of using CEXs
It is the gateway for crypto for many users as they are user-friendly and work similarly to traditional stock trading platforms. The dominance of CEX peaked over Defi-summer 2020, but has increased in recent months, to about 5-10% of DEXs volumes.
- They are familiar to users: The best centralized exchanges offer a compelling mix of user-friendly services that are more easily understood by end-users. They often offer financial products that mirror those found in traditional markets.
- Users can buy, sell and trade crypto, choose options and futures trading, apply for crypto loans, earn passive income, and more with a single login.
- These centralized products are easy to use and comprehend and can be accessed using a web browser, desktop or mobile app.
- Users do not need web3 specific knowledge or tools to use it (e.g. there is no need for a crypto wallet, only requiring login)
- The most important factors for financial products are creating trust and having a superior user experience: liquidity, security, and stability.
Furthermore, it is easier to increase the pace of innovation for CEXs, introducing new products and services to customers.
- This is especially at earlier stages of development, as teams can work in concert to build new features, fix bugs and produce the kinds of fine iterations that improve the overall user experience.
- DeFi protocols can be notoriously difficult to understand and access. Over the years, centralized finance (CeFi) platforms have gradually become more accessible and multi-dimensional, with sophisticated order-matching engines, asset custody and stable technology.
- They lower the barriers to entry to DeFi for users, allowing users to sample the benefits of DeFi, while retaining the liquidity, security and stability users are accustomed to with centralized finance (CeFi) offerings.
A comparison between CEX and DEX
|Access||Browser, mobile app, using traditional username/password; often has fiat-to-crypto on-ramp capability; permissioned access based on KYC, adherence to any regulatory oversight.|
Exchanges may also choose to geo-block countries (e.g. Kraken blocking Sudan, Somalia, New York)
|Browser, mobile app, using traditional username/password; often has fiat-to-crypto on-ramp capability; permissioned access based on KYC, adherence to any regulatory oversight.|
|Security||Same as web2 – the platform can be hacked or username/password compromised.||Greater personal responsibility is secure as long as the user does not give away wallet seed phrase or connect to spoof websites.|
|Regulation||Greater regulatory scrutiny – potentially greater regulatory assurance as well as security. This may come at the cost of slower speed to onboard and use the service and a more limited selection of cryptocurrencies available for trading. There is also the risk of sanctions that cut a user off access completely (e.g. Binance in Singapore)||There is no or limited regulatory oversight, typically no KYC and/or AML standards.|
|Asset Ownership||Acts as a custodian for the user, responsible for holding a ledger; consideration is that there is little-to-no recourse if assets are lost (E.g. mt Gox hacking), “not your wallet, not your crypto”||Self custody of assets through crypto wallet|
|Privacy||Increasingly less anonymous – requiring KYC as well as wallet ownership identification when transferring out of the platform||Anonymous – no KYC required|
|Trading price / liquidity||Spread depends on exchanges’ connections to liquidity providers; more prone to market manipulation (fake trading and wash trading)||Depending on the availability of the number of users/liquidity providers, typically use “automated market maker” (AMM) protocols (e.g. Compound, Uniswap, Sushiswap) to determine prices (they can also be order book DEXs – e.g. Gnosis Protocol or LoopRing), which will usually be close to CEXs because of the prevalence of arbitrage bots; lack of volume is a challenge (which may impact price – see below)|
Important consideration: Front running risk, as miners can preview transactions since they validate them, and this means they can front-run traders.
Note: Order book DEXs use algorithms through smart contracts to discover and move transactions among individual users. AMMs rely on using liquidity pools sourced from users rather than waiting to match buy and sell orders – liquidity providers may receive governance tokens that also ensure distributed governance and incentives in the DEX
|Trade execution speed||Typically in milliseconds, for market orders||Min. 15 seconds – transactions need to be validated on blockchains|
|Trading pairs availability||Crypto asset availability/listing is the platform’s decision and/or liquidity providers; at times, they have fiat/crypto trading pairs.||Often more extensive, no real limit on what is available for trade; however, less liquid pairs may result in high ‘slippage’ I.e. trading at a price different from what is listed, especially for large trades; typically, no fiat/crypto trading pairs.|
|Fees||Typically higher than DEXs (% of volume)||Typically lower than CEXs ($ per trade)|
|Market concentration||Global exchanges dominate volumes; however local players serve as convenient LCY-to-crypto on-ramp||Typically 1-2 big ones for each blockchain|
|Other services||Crypto launchpads: projects can apply to launch tokens, token airdrops (I.e. distribute free tokens)|
Staking: Users can ‘lock’ their tokens for interest
Financial products: futures and derivatives trading, leveraged trading
Others: customer support
|Swapping, Yield Farming, Liquidity Pools, Initial Farm Offerings, NFT profile pictures|
|Governance||Centralized – decisions are made by the owner(s) or a small group.||Distributed – many AMM-based DEXs use governance tokens, to democratize the control of the platform and as a reward mechanism for liquidity providers.|
CEXs and DEXs will co-exist as they each have their benefits. CEXs are important fiat-to-crypto on-ramp and crypto-to-fiat off-ramp for many users and are convenient ways to purchase crypto, especially due to their connections with local payments providers allowing users to purchase from or cash out directly to their local currency. The acceptance of DEX will be in-line with the adoption of blockchain technology, as well as better educated users and technological developments that make the usage more user-friendly. Ultimately, for the person in the street, the simplicity of CEXs may far outweigh the inconvenience of using DEXs, as well as the savings from quote spreads or fees, as the amount being traded is not large and the frequency is not high.
From an investment point of view, and by drawing parallels with tradfi, it is likely the case that there will be a few dominant global CEXs due to the advantages of having greater liquidity and hence better pricing, which users prioritize. Due to CEX’s key use case as on-and-off ramps, their local connectivity to payment solutions providers is important, thereby allowing users to easily buy and sell cryptocurrencies using the local currency. This will be a differentiating factor within any locality, and a potential moat for the business, allowing local players to thrive. As consumer knowledge and comfort on web3 and web3 increases, this advantage will erode and, as a result, accelerate the compression of margins and fees that these local players can charge, which has already been observed. At present, while the adoption of blockchain is increasing, it is still at a nascent stage and so this will likely occur over a multi-year time frame.
The compression of margins and fees will also impact the global exchanges, and the result will be extremely low fees to the user, much like traditional stock trading platforms today. It will thus be a volume game more so than it already is, and exchanges will also continue to innovate with new products and services (e.g. launchpads, staking, NFT marketplace) in order to diversify their revenue streams.