[Feature] DEX vs. CEX: What is the Future of Financial Systems?

As the financial landscape becomes more digitised, the way we trade assets is also changing. The emergence of cryptocurrency has disrupted the traditional financial system, creating new opportunities for investors and traders to profit from digital assets.

Decentralised exchanges (DEX) and centralised exchanges (CEX) have become an essential part of the digital asset market. They provide users with the ability to buy and sell various digital assets easily. However, the debate over which is better between DEX and CEX has been ongoing for years.

The layperson might not know or have a clear grasp of what DEX and CEX are. A DEX is a platform that allows peer-to-peer trading of crypto in a non-custodial manner without the need for intermediaries or a centralised authority. It uses a decentralised system of smart contracts, which are self-executing contracts with the terms of the agreement between buyer and seller directly written into lines of code. The smart contracts are hosted on a blockchain network, which ensures transparency and immutability of the transactions. Examples of DEXs include Uniswap, Kyber Swap, etc.

On the other hand, a CEX is a platform that operates with a central authority or a third-party intermediary. It facilitiates the buying and selling of crypto assets through a centralised order book, where buyers and sellers are matched by the exchange. CEX requires users to deposit their funds on the exchange, which creates a central point of failure, as hackers can target the exchange to gain access to users' funds. Examples of CEXs include Binance, Coinbase, the collapsed FTX, etc.

One of the topics discussed during the ongoing Consensus 2023, CoinDesk's annual conference, "DeFi vs. CeFi: A Distinction With a Difference", touched on DEX and self-custody, and whether decentralised finance (DeFi) is a viable alternative or is better centralised regulation (CeFi) a more realistic option. Held in Austin, Texas from 26 to 28 April, this three-day conference is a melting pot of major figures in crypto, finance, Web3, regulation, and the likes.

The panellists, consisting of Uniswap Labs' Head of Policy Salman Banael, dYdX's Marketing Lead Nathan Cha, and Maple Finance's CEO Sidney Powell, pointed out that "centralised exchanges have helped to push early adoption of crypto by the masses, but many of these have suffered from recent failures. In the long term, decentralised exchanges will strengthen the backbone of future financial systems.”

To touch on some of the key points of the panel discussion, as mentioned by Sidney using BlockFi and Celsius as examples, "the lack of transparency in a CeFi exchange is what eventually led to failures such as the spectacular collapse of FTX last fall. When a customer uses a centralised exchange the money goes into a wallet but everything behind that is controlled by an entity that isn't transparent and is not using blockchain infrastructure. Effectively, it was a private ledger." Though it is different for DeFi as it is more transparent in how money is being stored and moved. "The core difference [between CeFi and DeFi] is … self-custody. But more than that, from a technology perspective it's the use of smart contracts and a blockchain to actually operate the business.”

Salman explained that CeFi's advantage is "that their business model, with clear control persons, is reflected in kind of the regulatory infrastructure that we currently have", whereas DeFi's disadvantage in the same sense is its reliance on an open-source protocol that reduces "control surface area" from the perspective of regulations.

When one compares DEXs and CEXs, what are some of the key advantages and disadvantages of both of them?

Advantages of DEX
- More secure because they do not have a central point of failure. Transactions are recorded on a public blockchain, which ensures transparency and immutability.
- More privacy because users do not need to go through a centralised authority to trade.
- More resistant to censorship because of the lack of central authority that can be influenced by governments or other powerful entities.

Disadvantages of DEX
- Lower liquidity because they are still in their infancy.
- User interface can be more complex because users need to interact with smart contracts directly.
- Lack of customer support which means that if a user makes a mistake, they might not be able to get their funds back.

Advantages of CEXs
- Higher liquidity because they have more users and trading pairs.
- User interface is more user-friendly because users do not need to interact with smart contracts directly.
- There is customer support available.

Disadvantages of CEXs
- Less secure because they have a central point of failure.
- Less private because users need to go through a centralised authority to trade.
- More susceptible to censorship because the central authority can be influenced by governments or other powerful entities.

Both DEXs and CEXs have played a significant role in shaping our financial systems thus far. CEXs have dominated the crypto market, but DEXs are gaining popularity, especially with the rise of DeFi. DEXs are driving the move towards decentralisation (particularly among users who value privacy and autonomy), which could lead to a more equitable financial system. CEXs, on the other hand, offer the convenience of traditional finance, which could appeal to those who are not yet ready to make the jump to a completely decentralised system.

As blockchain technology continues to evolve and mature, it is likely that we will see more DEXs emerge. These exchanges will offer greater security and privacy, and will be more resistant to hacking and other security breaches.

Salman concluded that "over time the role of CeFi won't change drastically from what it is right now, whereas DeFi will eventually become the main infrastructure for the future of the financial system.”