An exchange is a platform where you can buy, sell, and trade different kinds of cryptocurrencies. Exchanges differ in terms of how they operate, the fees they charge, and the features they offer.
A centralized exchange, or CEX, is an exchange managed by a third party such as a bank or company.
A CEX uses order books to match buyers with sellers willing to trade fiat-to-crypto, crypto-to-fiat, or crypto-to-crypto, at a certain price. For instance, if a seller is willing to trade 1 Bitcoin for $50,000, the CEX matches him with a buyer willing to buy Bitcoin at that price.
Because centralized exchanges are backed by established financial institutions, they are usually less prone to issues with liquidity (the availability of funds for trading and withdrawal). They are also easier for beginners to use, but they usually charge higher transaction fees. To guarantee the safety of their customers, centralized exchanges impose know-your-customer (KYC) procedures which require users to share their personal information.
Centralized exchanges are mostly secure until the exchange is targeted by hackers or the liquidity providers go bankrupt.
A decentralized exchange, or DEX, is not managed by a third party. Instead, trades are settled through smart contracts and users have complete control over their crypto while transacting through the platform.
Some decentralized exchanges use order books to match buyers and sellers and post their transactions on the blockchain. But most DEXs operate using liquidity pools and automated market makers to facilitate token swaps.
A liquidity pool is a reserve of different currencies that any investor can contribute to via smart contracts, while an automated market maker sets exchange rates based on the amount of tokens available in the liquidity pool.
Compared to centralized exchanges, DEXs are more transparent, globally accessible, and privacy oriented. However, users may encounter bugs in the smart contracts and problems with lack of liquidity.
You can learn more about centralized and decentralized finance here.
Whichever type of exchange you use, take time to study its features, benefits, and risks. Happy trading, Ka-Bit!
