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What are cryptocurrency exchanges and why do I need to use one?
- Learn about CEXs, DEXs, why you need them and how to use them from this blog
- Centralized cryptocurrency exchanges, or CEXs, are the most widely used form of crypto exchange worldwide
- Decentralized cryptocurrency exchanges, or DEXs, allow you to exchange cryptocurrency directly with other users without using an intermediary
- If you’re new to cryptocurrency trading, it’s probably best to start with a CEX and learn how the market works
- DEXs provide an opportunity to take advantage of decentralized finance (DeFi)
- AMM: Automatic Market Makers create liquidity pools and set prices for trades. The term is often used to describe a decentralized exchange (DEX)
- Centralized exchange (CEX): A place to buy, sell, trade and stake cryptocurrency that is managed by a central human team
- Decentralized exchange (DEX): A place to swap, trade and stake cryptocurrency that is managed by digital smart contracts
- Liquidity pool: Groups (typically pairs) of different cryptocurrencies to which you can add your crypto in exchange for fees and LP tokens that sit on a DEX
- LP token: Tokens given to you when you deposit crypto into a liquidity pool
- Slippage: A token’s change in price as a trade is executed
- Smart contract: A self-executing and immutable digital contract written on a blockchain
- Staking: A way of claiming rewards from DEXs in exchange for depositing LP tokens
- Swap: Trading one coin for another through a DEX
- Yield farming: A method of increasing profits by providing liquidity
If you set up a wallet and bought some crypto after reading our post about buying cryptocurrency for the first time, congratulations! Now, let’s take a look at how cryptocurrency exchanges can help you further diversify your crypto portfolio.
What are CEXs?
Centralized cryptocurrency exchanges, or CEXs, are the most widely used form of crypto exchange worldwide. In fact, you most likely traded your fiat, or traditional currency, for cryptocurrency through a CEX. Besides exchanging fiat for crypto and vice versa, CEXs track orders and act as an intermediary for buying, selling, and trading a wide variety of digital assets.
Terms and conditions vary by CEX, but most centralized exchanges collect fees for their service and will require some form of KYC (Know Your Customer) information in order to use their platform. Unfortunately, due to government regulations, your location can affect your ability to trade with a CEX. However, non-KYC users may still be able to use a CEX with limited capabilities and limits on trading and withdrawals.
The top 5 CEXs in July 2022 taking into account average liquidity & volume are:
You should also check CoinMarketCap for up-to-date information on their top CEXs ranking, which tracks average liquidity & trading volume (the amount of money flowing through an exchange).
What are DEXs?
Decentralized cryptocurrency exchanges, or DEXs, allow you to exchange cryptocurrency directly with other users without using an intermediary. Most of these exchanges rely on self-executing agreements written in code (smart contracts), employing AMMs (Automatic Market Makers) to set prices and directly connect you with other traders.
No human or third party ever handles anyone’s assets on a DEX, hence the term “decentralized”. Your assets remain in your custody when trading through a DEX, so you may prefer using a DEX over a CEX if you lack trust in intermediaries holding onto your money.
Since no centralized third party holds traders’ assets, DEXs rely on user-funded liquidity pools to keep markets moving. To do this they use liquidity pools where users add their crypto, typically in pairs like ETH and YLD, for example, in return for a cut of trading fees and liquidity provider (LP) tokens. Often users can then stake their LP tokens on the same or a different platform to earn rewards in that platform’s native token. This is often referred to as yield farming, or liquidity mining.
Since DEXs do not ask for KYC, this can make trading possible for those unable to use a CEX. All you need to do is connect your Web3 wallet to a DEX, and you are ready to trade, no questions asked.
The top 5 DEXs in July 2022 by total value locked (TVL) are:
Since new DEXs are launching quite frequently, always check for up-to-date information about top DEXs.
Holding crypto on an exchange
CEXs take custody of, or hold onto, your assets while you are trading them. This makes CEXs an attractive place to store your crypto if you do not trust yourself to keep your digital assets safe. Several CEXs offer a native wallet that you can use to track your funds yourself.
Most CEXs claim to store the majority of their assets in a cold wallet, i.e. one that is not connected to the internet, as an extra security precaution. It is, however, impossible to verify what a CEX does with yours or anyone else’s crypto. It should be noted that if a CEX is successfully hacked, your money could be in jeopardy.
Since DEXs are decentralized, and there is no central authority holding your assets. While you trade, stake your crypto in a liquidity pool or your LP tokens for rewards, you remain the sole custodian of your own wealth.
Trading on a CEX
CEXs excel in the arena of replicating the trading environments offered by many platforms in traditional finance. As such, CEXs are often viewed as being more user-friendly than DEXs. CEXs usually provide how-to guides that walk you through using their platform, and many CEXs will let you practice trading on a test network. This can save you a lot of trouble as you learn how to trade.
Additionally, CEXs have a large store of crypto available for trading, in both variety and volume. Many CEXs can offer spot, margin (with varying degrees of leverage), and derivative trading due to their centralization, which only some of today’s DEXs offer. CEXs also allow you to set stop and limit orders in an order book, which can be a useful tool when trying to limit losses or buy new crypto in a volatile market, while only a few DEXs offer this feature, such as dYdX and Loopring.
Trading on a DEX
User interfaces for DEXs are usually quite plain and straightforward, but the lack of graphic design has not stopped billions of dollars of crypto trading through these platforms on a daily basis. DEX platforms usually have only a few buttons: Connect Wallet, Swap, Pool, and Rewards.
Trading on a DEX is quite simple:
- Click “Connect wallet” and verify that you would like to connect your wallet to the platform.
- Look for a box in the middle of the Swap page.
- Select the crypto you have and the crypto you want.
- Input the amount you want to trade, and the AMM will calculate the swap.
- Click the Swap button in this main box and verify the transaction with your wallet.
You can “look under the hood” and see how your transaction is processing using a link to the block scanner (Etherscan for trades on the Ethereum blockchain, for example) you can access from your wallet.
Trades may not go through if the value of one token fluctuates drastically mid-transaction, and you can account for these price changes, called slippage, by setting slippage limits to a higher percentage in the settings of the Swap screen (from 0.5% to 1%, for example).
Liquidity pools and staking
Liquidity pools allow for trades on a DEX to occur without a middle man, since they are run exclusively by smart contracts. This means that computer code is in charge of managing the pool instead of a human.
As mentioned above, you can become a liquidity provider yourself by placing crypto into a DEX’s liquidity pool. After that, you will receive transaction fees from activity inside that pool instead of a CEX getting those fees, while you can also stake your LP tokens for further token rewards.
Which exchange is best for you?
If you’re new to cryptocurrency trading, it’s probably best to start with a CEX and learn how the market works. When choosing a CEX, you should look at three factors: user experience, security, and trade volume. Furthermore, if you are not comfortable with the idea of tending to and safeguarding your own crypto portfolio, then a CEX might be a more suitable choice.
However, once you are more familiar with trading crypto, you will likely want to expand into the world of DEXs and take advantage of the wealth of opportunities they afford to participate in decentralized finance (DeFi). DeFi is still in its early stages, there are new innovations and opportunities to grow one's wealth emerging all the time.