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CEX vs DEX: Is DeFi taking over?

Decentralized exchanges or DEXs have been around for some years now. Some of our users may remember BitShares, which is still active, and other first movers in the decentralised finance space. 

In the context of recent upheavals involving well-established centralized exchanges (CEXs), more and more retail users are allegedly moving their funds to UniSwap, a DEX that has recently stolen the limelight. 

Uniswap’s average daily trading volume has jumped to about $220 million, according to data tracker CoinMarketCap.com.

So let’s go back to the basics to see why a DEX might be appealing and why in other cases, users may be better off trading on a CEX, such as Binance, Coinbase or AAX. 

Owning your assets 

Bitcoin was created to make it possible to create, transfer and hold digital money online, without the need for any centralized intermediaries – like banks. 

Of course, as trade in Bitcoin and other cryptocurrencies became more prevalent, apart from peer-to-peer and over-the-counter trading, the industry quickly saw the rise of centralized exchanges that function like stock markets.

While blockchain technology is very secure, centralized exchanges have often been the target of large scale hacks, and in some cases insiders have gone rogue. 

On DEXs users don’t relinquish custody of their assets. Instead, they are themselves responsible for the safety of their funds and they trust smart contracts when engaging in trade – or other economic activities. 

For some users, such controlled ownership is important. However, other users may prefer to hold their assets with CEXs – when things do go wrong, the exchange can be held accountable or in other cases may be able to accommodate users and provide assistance. 

Especially institutional investors will hesitate to move their capital into unregulated liquidity pools. Moreover, CEXs now hold most of their client assets in cold storage, and custody providers such as Koine, Fidelity Digital Assets Services and Copper, make it possible for clients to securely hold assets in insured third-party custody with the option to trade on multiple centralized exchanges from a single terminal. 

Liquidity 

Liquidity has for years been a major advantage held over DEXs, and while there has been considerable growth on platforms such as UniSwap, overall CEXs provide better liquidity. 

But it’s also about the long term plan. CEXs may record volumes in the billions, but it’s still not much compared to gold markets or say forex, where trillions of dollars is traded. 

Handling institutional volumes is a matter of technology as much as it is on uptake. At AAX, we use LSEG Technology’s proven matching engine that is also used by London Stock Exchange and other first tier markets. Other centralized exchanges are also capable of handling sizeable order volumes – this is where there is still a lot of room for growth across the board, but particularly on DEXs – and that does not even address other elements of the wiser market infrastructure that determines the resilience and suitability of an exchange for mainstream adoption. 

User experience 

User experience is another key factor to consider. Trading on a DEX is not as straightforward as it might sound, not if you want to avoid bad rates and slippage. Yield farmers are able to make significant profits in the space, but those that navigate the DeFi space well, usually know what they’re doing. 

By all accounts, trading on a CEX or for example placing your crypto in a savings account to earn an interest on AAX is easier than undertaking such activities on a DEX such as UniSwap

For institutional investors, however, the DeFi space is of interest, and CEXs such as Binance, FTX, AAX and others have been quick to list a wide range of DeFi related crypto assets, including UNI, as well as perpetual futures contracts to hedge positions. This enables the wider investment community, that may not be participating in the DeFi space, to invest and gain exposure.

Retail users may navigate multiple venues, looking for arbitrage opportunities

How things will develop from here, is unclear. But at AAX, we see the DeFi space and that includes DEXs as a vital sector of the crypto industry, and we believe CEXs have an important role to play to connect the wider investment community, including institutional investors, to the crypto industry as a whole, including these most niche, experimental and innovative corners of the market. 

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