Cryptocurrency exchanges are platforms that facilitate the trading of cryptocurrencies for other assets. In effect, cryptocurrency exchanges act as an intermediary between a buyer and a seller and make money through commissions and transaction fees.
Centralized exchanges (CEXs) act as a third party between buyers and sellers. On the other hand, decentralized exchanges, also known as DEXs, are peer-to-peer marketplaces where cryptocurrency traders make transactions directly without handing over the management of their funds to an intermediary. These transactions are facilitated through smart contracts.
The services offered by a centralized exchange, such as Coinbase, Binance, Bitfinex, and such, can be compared to those offered by a bank. In contrast, decentralized exchanges, such as Uniswap, Defi Swap, Curve, and more, allow users to trade directly from their wallets by interacting with the smart contracts behind the trading platform.
DEXs are designed to overcome some of the issues that plague CEXs. Since a CEX is operated by a company that oftentimes holds billions of dollars worth of cryptos, they are often in the crosshairs of hackers. In fact, there have been several such attacks in the past, and hacked exchanges have become a major reason for investors to lose their cryptos.
A DEX cannot be hacked in the same way, since there is no central repository that holds all funds. Also, thanks to the use of smart contracts, DEXs offer unprecedented transparency into the underlying mechanics of trading and come with strong execution guarantees.
DEXs have experienced increasing adoption in the last few years. The current crypt crash has led to an extreme liquidity crunch for some CEXs who have been forced to prevent their users from accessing their own funds. Some others have become notorious for their frequent crashes. At the same time, DEXs have been evolving constantly in order to become more accessible.
So are DEXs the way of the future?
According to blockchain researcher Chainalysis, the volume of on-chain transactions on DEX has already eclipsed CEX. “From April 2021 to April 2022, $175 billion was sent on-chain to CEXs, well below the $224 billion sent to DEXs,” shared Chainalysis.
Explaining the reasons behind this growth, it said that while most CEX transactions happen off-chain on centralized databases and are captured on their order books to save on transaction fees, every DEX transaction occurs via smart contracts on-chain.
Chainalysis argued that whether DEXs will be able to keep their lead in on-chain transaction volume over CEXs depends on a number of factors, including fees, and regulatory scrutiny.
“As DeFi competition intensifies, it will be interesting to see how CEXs and DEXs converge and differentiate,” observed Chainalysis.