What are Cryptocurrency Exchanges? A brief explanation of Centralized and Decentralized Exchange
A cryptocurrency exchange is a platform through which you can buy, sell, or trade cryptocurrencies like BTC, ETH, BNB, and more.
There are two types of cryptocurrency exchange: Centralized Exchange (CEX) and Decentralized Exchange (DEX).
Before diving into the world of cryptocurrencies, you need to understand the difference between these two types of exchanges.
Understanding Centralized Exchange (CEX)
These are trusted third-party exchanges that facilitate trades between buyers and sellers. Centralized exchanges minimize friction and increase convenience in trading.
A centralized exchange is owned and controlled by an entity and regulated by authorities like the SEC. CEX users must complete the KYC process and provide personal information like address and tax ID. Centralized exchanges also require users to deposit money before trading.
These exchanges allow users to trade crypto with crypto or a government-issued currency. It also allows users to cash out crypto.
Popular centralized exchanges include Binance, Coinbase, and KuCoin.
How does a Centralized Exchange work?
Centralized Exchanges maintain an order book containing the trades of users.
It includes buy or sell requests placed by a user for a specific cryptocurrency and at a certain price. CEX uses proprietary software to match and execute these orders.
Understanding Decentralized Exchange (DEX)
Decentralized exchange is a cryptocurrency exchange that facilitates peer-to-peer trading and operates without central control. DEX relies on its community of developers and members across the blockchain network.
DEXs are part of the decentralized finance or the Defi ecosystem. Defi is a term given to financial services that have been decentralized with blockchain technology.
If you’re not familiar with DeFi or Blockchain technology, read this article.
No authority regulates decentralized exchanges. Users don’t have to sign-up or provide any personal information to start trading.
Additionally, you don’t have to deposit money into the platform. You can send or receive coins directly through your crypto wallet, giving you complete control over your funds.
The DEX market runs on a blockchain network and is validated by an agreed set of rules called a consensus mechanism.
How does a Decentralized Exchange work?
The main difference between a decentralized exchange and a centralized exchange is how trade is conducted in them.
Unlike a centralized exchange, there is no order book or a third party that handles transactions in a decentralized exchange. A DEX uses smart contracts to conduct transactions.
On most decentralized exchanges, users don’t trade with one another. The trades are conducted within a liquidity pool.
Liquidity pools are shared funds deposited by the exchange users. Users who lend funds in a liquidity pool are called liquidity providers.
A DEX uses a mathematical formula to determine the price of a particular cryptocurrency. This formula or algorithm is called Automated Market Maker or AMM.
Centralized exchanges have existed for years, and these exchanges have matured a lot with time. Decentralized exchanges, on the other hand, are the new wave in the trading market.
However, this doesn’t mean that they are better than CEX. Both have their benefits. When selecting an exchange, keep in mind the advantages and disadvantages of both and choose whichever suits you the most and provides better security for your assets.
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