CEX/DEX/DeFi (part 3/3)
In the 2nd article, we covered some technical aspects (gas token, transaction fee, smart contract, token address). In this one, we will address the key differences and similarities between a CEX, DEX and DeFi application.
In crypto space, there are two competing environments for trading:
- Centralized Exchange (= “CEX”) platform: Is more related to a traditional institution, but which allows trading of crypto tokens
- Decentralized Exchange (= DEX) platform: Operates in the DeFi world, no central authority and trustless (no intervention of a trusted 3rd party).
And there is a whole host of Decentralized Finance applications, like Oh! Finance, on the blockchains and specializing in different business domains (gaming, lending, NFT marketplace, etc).
A CEX is managed by a company complying to legal rules:
- For the vast majority of them, you will need to pass a KYC procedure (= “Know your customer”) to be allowed to deposit (from a bank or from a crypto wallet) or withdraw assets. You will be asked to upload a real proof of identification, an invoice to prove your home address, and your face picture. You will have to trust the platform that they have all the security in place to not leak your personal information.
- You receive a unique wallet address linked to your account and which allows you to transfer tokens with another CEX wallet or with wallets living in the DeFi world. That wallet address is linked to your real identity.
- Walled garden: The tokens you trade are technically yours when you consult your balance on the platform. In reality, they only live in the CEX ecosystem and are registered to your CEX wallet only inside the CEX system. Outside of the CEX environment, nothing proves that these tokens are yours, they are not registered on the blockchains with your wallet address.
Drawbacks of a CEX:
- The assets in a CEX wallet are not truly in your custody.
- If the CEX shuts down for maintenance, you have no access to your assets. You can’t import the CEX wallet address content to MetaMask with a seed phrase to retrieve your assets. A CEX is not true DeFi.
- More exposure to government seizure of its assets: Risk of losing your investment.
- A CEX doesn’t have access to all the tokens of the DeFi world.
- Disabling withdrawals to an external wallet is frequent on some popular platforms. You can only wait for the CEX to re-enable them and you may miss investment opportunities.
Why would you register on a CEX?
- Easier gateway to transfer fiat money into crypto: A CEX has more options than a DEX to accept bank/credit card transfers.
- As a trader: Not subjected to price impact issues in case of big trades compared to a decentralized exchange platform (= “DEX”). You are also guaranteed that the trade will be instant with the price you wanted, no risk of cancellation after the trade has been accepted. Buy and sell orders are simply managed through order books.
On a DEX, there is an automated marker maker (= “AMM”) regulating the price based on algorithmic rules. One of the parameters is supply vs demand to estimate the price of an asset at the time of buying. The AMM will consider that a big buy compared to the available supply introduces a big demand, which will create scarcity and the market price is adjusted accordingly (law of supply vs demand). You will end up paying a higher price than the initial one when the trade was initiated (“called slippage”).
- Depending on which blockchain you trade and at which moment, trading fees may be lower on a CEX than on a DEX.
- In case of technical issues, a more organized support may be available with their helpdesk
- Recover access to your account if you forgot or lost your credentials (password reset for example). If you lost your seed phrase with a DeFi wallet, then you will never be able to access your assets linked to that wallet if you lost access to it.
- All the trading and features are centralized, with a uniformed user interface. May be initially less daunting to trade in crypto.
A DEX is a decentralized exchange platform:
- Is a type of DeFi application, with as core functions trading tokens and providing liquidity to earn rewards
- You only need a wallet app compatible with the blockchain where the DEX is residing, a wallet address and enough gas tokens for the transactions: No account creation, no KYC.
- A DEX is not a custodian of the tokens in your wallet, you are: Should anything happens to the DEX, the tokens in your wallet are still yours and you can trade on any other DEX
- With the same wallet, you can trade on many different DEXs operating on the same blockchain. Every transaction is registered on the blockchain. You don’t need to transfer assets from a DEX to another to trade, like you would need to with a CEX.
- Market prices are automatically regulated with an AMM
- Trustless transactions (doesn’t mean it isn’t trusted, especially if the project has been audited): “Smart contracts” define the transactions characteristics/rules and act as the technical middleman to execute a trade and register the transactions automatically on the blockchains. No human intervention and no need for a trusted 3rd party.
- Crypto projects can be listed very quickly on a DEX without paying (sometimes extortionate) listing fees like on a tier 1 or tier 2 CEX. Brand new tokens are available right away.
- Depending on the blockchain, often cheaper to trade compared to a CEX
- When you enter liquidity pools: No expensive withdrawal fees and you can withdraw any time. Besides, you also earn a share of the DEXs transactions, which may not be not the case on a CEX.
- A transaction is always a manual two step process: Approving and then executing. Not possible to “fat finger” a trade.
- They share many characteristics as a DEX: You are a custodian of your assets in your wallet, no account creation and KYC, low transaction fees, no official regulation imposed on the project, etc
- All transactions are registered on the blockchains and registered to your wallet
About OH! Finance
Oh! Finance is an optimized yield-generation protocol, focused on reducing risk and increasing volume exposure. Start earning industry-leading interest rates on stablecoins in just a few clicks: https://oh.finance
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