Blockchain technology brought real technological advancement as it introduced the concept of decentralization. Industries, particularly finance and trade, relied on centralised exchanges to conduct business. However, banks and financial institutions are supervised by centralized bodies and it takes a long time to approve transactions.
The emergence of Bitcoin highlighted the evolution of stock exchanges and steered everybody’s attention toward blockchain. It became a widespread technology as more people started to use it for its outstanding characteristics. As we are learning about the innovations brought by blockchain, let’s read about them while comparing decentralized technologies to traditional exchanges. The blog will be an eye opener comparing centralized exchanges, DEXs, and swaps.
What is a centralized exchange?
A centralized exchange offers a seamless exchange of digital assets such as Bitcoin, Ethereum, Polygon, Solana, and even tangible assets. Centralized exchanges (CEX) are handled by a single (or central) authority that acts as a middle person between the buyers and sellers. The transaction fees and commissions generate revenues for the centralized exchange.
Popular centralized exchanges also have high trading volumes as they have less volatility and fewer risks of market manipulation. CEXs also help companies to launch exchanges where people can trade, invest, and earn decent returns. However, users have witnessed a gradual shift from centralized trading to decentralized trading.
For example, Binance, Kraken, KuCoin, and Coinbase Exchange are some examples of centralized exchanges. The difference between a centralized and a decentralized exchange is that a central authority regulates the former, while a single entity does not control the latter.
How does a centralized exchange work?
We have already discussed how a single authority controls the centralized exchange and manages traders’ funds. A CEX requires traders to trust the exchange to perform trades. A user has to complete KYC to be able to execute trades on the exchange. The user can deposit the money in their wallet, for which the exchange issues IOUs to them.
A centralized exchange utilizes the Order Book Method to execute trades. The method records the open orders to enable the buying and selling of assets. A trader can buy an asset by disclosing the price to the exchange. Once the order is matched with the seller, it swaps the assets and completes the exchange between them.
What is a decentralized exchange?
A decentralized exchange (DEX) allows users to trade their assets on the blockchain securely and transparently. DEXs function without intermediates and possess all the features of a centralized exchange. Also, a decentralized exchange has an enormous number of tokens listed on the exchange for facilitating trade.
For example, Uniswap, ViteX, Binance DEX, and Nash Exchange are some examples of decentralized exchanges. DEXs harness the power of smart contracts to provide security and simplify the exchange process. On the contrary, a centralized exchange requires third parties to look after the security and manage funds.
How does decentralized exchange work?
Decentralized exchanges allow users to trade cryptocurrency tokens for other cryptocurrency tokens. DEXs do not allow exchanges between fiat and crypto, meaning you can trade fiat for crypto via a centralized exchange.
Decentralized exchanges use smart contracts as they algorithmically establish the prices of various cryptocurrencies to facilitate trades. While transactions on a CEX are recorded in the exchange’s own database, DEX transactions are settled directly on the blockchain.
Decentralized exchanges are built on open-source code, meaning anyone can see exactly how they work. Developers can adapt existing code to create new competing projects. For example, DEXs like Sushiswap have adopted Uniswap’s code.
What is a swap?
A non-native token swap helps to exchange two non-native tokens between different blockchain protocols instantly. The best part about the swap is that it facilitates exchange without the need for token migration or crypto-to-fiat exchange. Swap enables users to exchange tokens directly from the official private key wallet or the trading account.
For example, SwapSpace, Changelly, and Shapeshift are some examples of swap-enabled exchanges. Users also use swap technology as it allows hedging against risks. Also, swapping will enable traders to swap the growing asset and shift to any stablecoin from a volatile asset.
How do swaps work?
Swap allows users to swap tokens in a simple, fast, affordable, and secure manner. It facilitates seamless crypto-to-crypto exchange and saves users from undergoing the time-consuming fiat-to-crypto process. Exchanges, wallets, and other blockchain-oriented trading platforms offer the swap facility to users.
A swap-enabled exchange platform allows a user to exchange any native token for a non-native token directly from the official crypto wallet. It only requires the total amount and the desired trading pair to perform swaps and exchange tokens from a different blockchain.
Exchange vs. Dex vs. Swap
|Centralized Exchange (CEX)||Decentralized exchange (DEX)||Swap|
|A centralized entity regulates it.||It uses smart contracts to regulate the platform.||It is similar to DEX as only smart contracts regulate swap-enabled platforms.|
|CEXs are vulnerable to security breaches or data manipulation because they are under the control of third parties.||DEXs offer robust security to users because expert validators are present to validate each transaction.||Swaps share the same security as that of DEXs.|
|The exchange requires users to verify themself via KYC.||Users can trade anonymously on a DEX.||Swaps do not require any verification process.|
|SInce exchange has the custody of your funds, it is accountable for security.||DEXs are decentralized. Hence, users are responsible for their security.||Swaps are decentralized. Hence, users are responsible for their security.|
|Since third parties help to function the exchange process, it is costly to users.||DEXs are much more affordable, with zero commission and transaction fees.||Swaps do not charge for any swap between a trading account to a trading account.|
|CEXs share popularity among a wide range of traders.||DEXs are coming to the limelight and are more prominent than centralized exchanges.||Swap technology is famous among traders for seamless exchange.|
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Frequently Asked Questions (FAQs)
Q1. What is the difference between a DEX and a swap?
Ans. DEXs allow users to trade with zero transactions since they don’t have third parties, while Swaps help users save network fees by facilitating direct exchanges between trading accounts.
Q2. What’s the difference between a swap and an exchange in crypto?
Ans. An exchange only allows trading between the available pairs listed on the exchange. However, swap offers more flexibility as users can swap any cryptocurrency for another even if the pair is not live on the spot market.
Q3. Why is CEX faster than DEX?
Ans. Due to their entrepreneurial and commissionable nature, the CEXs are a bit faster, while the DEXs are more opaque. The fees are more efficient and reduced in a CEX than in a DEX because the latter also has to pay the network.