What is a centralized exchange (CEX)?
Over the past few years, the Cryptocurrency industry has become increasingly popular. It’s incredibly risky and traders need to know what they’re doing. Prices can rise and fall at lightning speeds. This high risk aspect has been the reason why many stay clear of crypto, but is also one of the reasons why so many investors have entered the space in recent years.
With that said, in order to trade cryptocurrencies, you first need an account on a cryptocurrency exchange. There are two types of trading platforms out there, one being centralized exchanges (CEX) and the other being decentralized exchanges (DEX). This guide will primarily focus on explaining what a centralized exchange is and how it works. However, we will also be discussing DEXes as we explain what they are and how they differ from centralized exchanges.
What is a centralized exchange?
A centralized crypto exchange, or CEX, is an online cryptocurrency trading platform. As the name suggests, a trading platform of this kind is centralized. This means that it is operated and managed by a centralized authority — usually by the company that created it. Centralized exchanges were the first type of crypto exchanges to appear.
Initially, CEXs were anonymous and you could use one without revealing your identity. However, as more and more people started to use these exchanges, global financial regulators became concerned about the anonymity aspect of exchanges, which is why this has now changed. Now, users must verify their identities in order to trade.
Centralized exchanges are known for offering a variety of orders to enhance your trading experience. You can use limit orders, stop-loss orders, stop-limit orders, margin trading and leverage trading. Most exchanges keep the majority of their assets in cold storage. That way, the assets are not connected to the internet and they cannot be stolen. The only funds that can be stolen are the ones contained in so-called hot wallets.
The hot wallets represent the assets that are used to ensure liquidity, and users’ assets. This is why it is recommended to always withdraw your funds once you are done trading. Once your assets are back in your private wallet, it becomes much harder to steal. But, generally speaking, CEXs are fairly safe with plenty of security protocols in place to preserve your funds.
How does a CEX work?
A CEX is fairly simple to use and uses similar sign up practices that are used within traditional finance. It requires you to open an account, verify your identity and deposit some funds. Once this process is complete, you are free to trade. You can do this by submitting a market order, which then gets stored in the platform’s order book. Once the sell order matching your buy order appears, the two get matched, and a trade is executed.
Like in traditional finance, where you have a maker fee and a taker fee, crypto trading also includes transaction fees. In fact, transaction fees are centralized exchanges' primary source of income.
What services can a centralized exchange offer?
A CEX plays several primary roles when it comes to crypto trading. Those include order matching, custody and acting as a clearing counterparty.
Order matching was briefly explained earlier. Essentially, when you wish to buy cryptocurrency, you submit a buy order. If you wish to sell cryptocurrency, you submit a sell order. The orders get stored in the order book, where they wait for a match. If someone offers to sell the same amount that you are buying, the system will match your orders. For its service, the exchange charges transaction fees. Of course, this also means that you do not buy from the exchange itself, but from another trader. The exchange simply acts as a middle man.
Next, we have the exchange’s role as a clearing counterparty. This role helps protect users privacy/ identity by matching orders against the exchange. As stated above, users are technically purchasing crypto from other users. However, in order to protect user identity, the transaction is marked against the exchange opposed to the user.
Lastly, CEXs also play the role of a custodian for both cash and crypto. We mentioned this as well when we said that you have to deposit money into your account. Once you deposit money, it is being kept safe by the exchange. Therefore, it is in its custody. After you buy crypto, it is stored in your portion of the exchange’s wallet. Until you withdraw it to a private wallet, these coins and tokens are also in the exchange’s custody.
Benefits of centralized exchanges
Centralized crypto exchanges come with many benefits, which is why they are still extremely popular. For example, they are very user-friendly, which wasn’t always the case. Once centralized exchanges became more popular, the user interface was simplified. Today, the user interface is so simple that even a first-time crypto user can easily navigate it.
Exchanges also offer support and protection, which is crucial for less experienced traders. Users are able to trade on exchanges knowing they are safe and protected, which means they are less likely to get scammed. It’s also worth noting that, for the most part, if a security breach happens and funds do get stolen, exchanges will cover your loss.
Apart from that, a CEXs simply offers a wide range of products and integrated services, which means everything is in one place, making it easier for users to manage their assets. Some platforms offer staking, NFT Marketplace , seemingly endless liquidity, launchpads, P2P exchanges and more.
Downsides of centralized exchanges
Unfortunately, centralized exchanges also have a couple of downsides. These are not deal-breakers for most people, but they are something that you should be aware of.
For example, we mentioned that centralized exchanges are still prone to being hacked and as a result your funds could be stolen. These platforms invest massive amounts into security protocols, but hackers sometimes find a way to breach them. A lot of the time, it is human error that leads to hacks and not a failure in the system. The best thing you can do is to not keep your money on a CEX after you finish trading. Withdraw it to a private wallet, where only you hold the private keys. If you can use cold storage (offline, hardware wallet), that’s even better as it’s considered the safest way to store digital assets.
Another downside to centralized exchanges are their transaction fees. Whether you are buying or selling, there are transaction fees to pay. Although these are typically low, they do add up over time, so be wary about them.
Arguably one of the biggest downsides is handing over the custody of your assets to the exchange. The crypto industry has a saying — not your keys, not your coins. Since the exchange holds private keys, it can confiscate or freeze your funds at any time. This brings your ownership of the coins into question. Do you really own the money that someone else can take with a push of a button?
Is there an alternative to a centralized crypto exchange?
Over time, the crypto industry has become increasingly irritated with certain aspects of centralized exchanges. Centralization itself is against everything that crypto and blockchain stand for. So, developers decided to try and build an alternative — a decentralized exchange. At first, these attempts were mostly unsuccessful, with the main issue being the lack of liquidity.
DEXs had very limited liquidity, so no one wanted to use them. Then, a concept of an automated market maker (AMM) came into existence and DEXs were revolutionized. Today, these platforms allow users to stake their coins and tokens. In doing so, they receive rewards, while the platform builds a liquidity pool that it can use.
What is a decentralized exchange?
A decentralized exchange is a crypto exchange that is not managed by a single entity. It is an automated platform built using smart contracts and is ran by the community and algorithms. As such, a DEX runs entirely on blockchain technology. Smart contracts handle the orders, there is no custody and as a result, security is much tighter.
Since becoming functional, DEXs have revolutionized crypto trading once again. They have contributed to pushing the crypto industry down the path of true decentralization.
How a decentralized exchange works?
A Decentralized exchange works similarly to a centralized exchange in many ways. However, there are some crucial differences that also make them different. For example, you don’t have to deposit money into a DEX and they don’t use order books to match orders. Instead, they use an automated market maker and settle orders from the pool of available funds.
Let’s say that you wish to trade a cryptocurrency that runs on Ethereum’s blockchain. First, you would have to go to an Ethereum-based DEX, such as Uniswap. Once there, you would see a variety of trading pairs. You would then have to connect your personal wallet to the exchange and submit your order. The DEX would fulfill it by using the funds from the AMM and your trade would be complete. The tokens would go directly into your wallet, with no deposits and withdrawals needed.
Users aren’t required to set up an account either, this reduces the entry barriers for DEXs. There are still some issues with the DEXs, such as occasional liquidity struggles. They are also a bit more complicated to use and they lack fiat on and off ramps, which means that you can’t buy assets with fiat currencies.
Which one do I use, a DEX or a CEX?
This is entirely your decision to make. Both CEXs and DEXs have benefits and downsides. CEXs can be more convenient, while DEXs are more decentralized and offer greater freedom and security. Over time, they will likely become more convenient and easier to use, but for now, CEXs still have the upper hand in that regard.
FAQs
What does CEX stand for?
CEX is short for Centralized Exchange. This is a crypto trading platform owned and operated by a centralized entity. CEXs offer greater convenience, but their centralization is not in the spirit of crypto.
What is an example of a CEX?
Centralized exchanges can be found throughout the crypto industry. One example is OKX exchange, which also offers a decentralized version. OKX DEX is considered highly secure and perfectly safe to use.
What is a CEX in crypto?
CEX is a centralized crypto trading platform that offers assets from across the crypto industry. CEXs have assets from multiple blockchains, they match orders through order books, and they keep assets safe in cold storages.
What is the meaning of CEX and DEX in crypto?
While CEX stands for Centralized Exchange, there is an alternative called DEX. DEX is short for Decentralized Exchange, which run entirely using smart contracts. A CEX is operated by a company, while the system and its community operate a DEX.
