One of the hurdles of cryptocurrency adoption is exchangeability. Better put, how to exchange one crypto asset for another. Over the years, the crypto space has successfully passed the stage. The question is whose domain is the exchanges. Hence, the topic: centralized and centralized exchange comes to mind. As demanding as the difference between centralized and decentralized exchanges is, it is interesting to understand what a cryptocurrency exchange first.
What is a cryptocurrency exchange?
A cryptocurrency exchange refers to a market that allows the buying and selling of cryptocurrency. Cryptocurrency adopters trade cryptocurrency as they would trade fiat in forex. Due to the progression of crypto, it is expanding from centralized to decentralized exchanges.
CeX and DeX: what are they?
Cryptocurrency trading started in centralized exchanges before emerging to decentralized exchanges. Nonetheless, both exchanges have successes and failures alike. Centralized exchanges are popular as a custodial marketplace for trading crypto assets. On the other hand, decentralized exchanges allow non-custodial trading of the crypto assets marketplace. Simply put, the major difference between DeX and CeX is the control and who manages it.
By custodial, we refer to third parties who control and regulate transactions. For a CeX, third parties regulate the exchange of crypto assets. On the contrary, the DeX leverages Blockchain functionalities to settle trades and make decisions.
Furthermore, both have ways of solving the liquidity problem. They include the order book model, automated market makers. However, the order book method is not exclusive to centralized or decentralized exchanges while automated market makers are an improvement of the order book model for DeX.
Order book model
Although centralized exchange takes credit for using order book to make the markets, the decentralized exchanges are currently improving on it. An example of such DeX using the order book model is 1Inch exchange among others.
In order book models, a marker and taker bets or speculate on the price of assets. Both parties place an order and once the taker agrees, the order gets filled.
The order book is a market mechanism for listing buy and sell orders. That way, takers and makers access the quantity and price of the assets. Although it helps provide liquidity, it takes time for aggregating all the data among other issues like slippage and latency in price discovery.
There are some improvements nonetheless for order book models. Such improvements are the on-chain of the EtherDelta in mid-2016. Others include Off-chain execution, on-chain settlement adopted in IDEX, and DDEX. However, the limitations of the order book necessitated the automated market makers’ method of providing liquidity.
Automated market makers
Unlike the order books, automated market makers don’t need third parties to decide prices, slippages, etc. Instead, they leverage blockchain smart contracts to make markets. Thus providing liquidity without a third party.
Automated market-making, first employed by Shearson Lehman and Brothers was an idea to use technology to reduce the chances of human manipulation and bring liquidity to the market.
Essentially they are a set of algorithms or rules that replaces the maker-taker relationship in the order book. Simply put, it uses “if this, then that” statement to automate deals. Examples of such exchanges leveraging AMM are Balancer, Uniswap, Trustswap, and so on.
Conclusively, CeX and DeX are direct opposite of another . However, they have attained successes in peer to peer exchanges. although DeX are doing impressively well, it has attributes of CeX. On the other hand, third party manipulates the order book model sometimes.
Okereke has a passion for researching blockchain and cryptocurrency. He enjoys creating long form educational content to inform others on the opportunities in this space.