What is an exchange?

A cryptocurrency exchange is a digital marketplace where users can trade cryptocurrencies and other digital assets. There are two main types of crypto exchanges: centralised and decentralised.

Centralised Exchanges 

A centralised crypto exchange (CEX) is a platform where transactions are coordinated by an identifiable centralised company. 

CEXs typically facilitate trades by matching the orders of someone who wants to buy assets with someone who wants to sell by maintaining an order book. An important point to note is that when you hold your money on a CEX, it’s like holding your money in a bank. 

It may be safer than keeping the money yourself (tucked under a mattress, or in a biscuit tin etc), but you are at the whim of the custodian. They are holding your coins, and in some cases, they may have the right to hold onto them when they become insolvent (for whatever reason). 

CEXs are the first step into the crypto world for most people, as they are fiat on and off ramps (easiest way for depositing or withdrawing Dollars, Euros, etc.). 

Examples include Binance and Coinbase. 

Decentralised Exchanges 

A decentralised crypto exchange (DEX) is a platform where transactions occur ‘peer-to-peer’, or ‘peer-to-pool’ (directly between crypto traders or through liquidity providers) without the need for a middleman, like a bank or a broker.

There are three main types of DEXs: Automated Market Makers, Order Book DEXs and DEX aggregators. Peer-to-peer transactions on all of these are facilitated through smart contracts (a set of computer code that performs pre-determined agreements).

DEXs are completely on-chain. This means that while transactions on CEXs are generally recorded on an internal database, DEX transactions are recorded directly on the blockchain. DEXs are also typically built using open-source code, so anyone has access to see exactly how they work.

Note that instead of setting up an account with a DEX, users simply connect their crypto wallet. There’s no KYC (Know-Your-Customer), or any other checks that could be used against you to prevent you from using the service. In other words, it’s completely private.

Examples include Uniswap, a popular decentralised exchange designed for trading and providing liquidity for Ethereum (ERC-20) tokens that uses an Automated Market Maker (AMM) model, and dYdX, a decentralised exchange with a focus on perpetual futures (perps) trading that operates via an order book model.

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Security & usage

Decentralised exchanges offer a fundamentally different approach to security compared to centralised exchanges (CEXs). 

In DEXs, users maintain control over their private keys, meaning they retain full custody of their assets at all times. This setup mitigates the risk of losing funds due to the exchange being hacked, a common concern with CEXs. However, this also places the responsibility of security squarely on the user, necessitating a strong understanding of safe crypto storage practices, such as using hardware wallets for added security (see Module 10). 

The user experience and the level of technical knowledge required significantly differ between decentralised exchanges and centralised exchanges, with DEXs presenting a steeper learning curve for users.

Engaging with DEXs involves direct interaction with blockchain technology, requiring users to manage their own wallets, understand the mechanics of smart contracts, and navigate the complexities of network fees, commonly referred to as gas prices. Gas prices, in particular, add an additional layer of complexity and planning, as users must adjust their transaction fees based on network congestion to ensure the timely processing of their trades. 

In contrast, CEXs offer a more streamlined experience, handling the technical aspects of trade execution behind the scenes, providing a simpler interface, and requiring less specialised knowledge from the user. This makes CEXs more accessible to beginners but comes at the cost of giving up control over one's private keys and potential concerns over security and privacy. 

The choice between crypto exchanges - DEXs and CEXs thus often comes down to a trade-off between the desire for autonomy and privacy versus the need for ease of use and simplicity in trading operations.