????#DEFI FOR NORMIES????: #CEX?? vs #DEX??

Exchanges are some of the most important protocols in?#crypto, since they are literally how anyone generally obtains cryptocurrencies. Here’s a beginner’s guide to the differences between CEXs and DEXs.

What is a CEX? A Centralized Exchange. Much like a stock exchange, a CEX is a marketplace for financial assets. In this context, specifically cryptocurrencies. It’s a 3rd party that facilitates order matching and asset storing.

So, imagine it’s like Amazon…but for cryptos. Most CEXs work off “order books” so that means that for every buyer there must be a seller, and vice versa. This is also like Amazon. When you go to a CEX you can buy cryptos from people selling, or sell to people buying.

Another way that CEXs are like Amazon is that they make it super easy to buy. Just like the “buy now” button where you can buy products online with your credit card, most CEXs have a “fiat on-ramp” meaning they can take credit card (or sometimes Paypal) payments for crypto.

Once you buy your crypto, unlike on Amazon, nothing gets sent to you, however. Your crypto is in the exchange. That’s because CEXs operate on a custodial framework. Meaning, until you send your crypto out, they retain custody of your tokens.

This can be advantageous because it means you don’t have to switch blockchains or….do anything really. That is why CEXs are so popular. Because it is easy for a beginner to use one. They can simply go to a CEX, use their Visa to buy some tokens, and call it a day.

Those are the benefits to CEXs. However, there are some hefty downsides. First, because they have custody of your tokens, and because they are so heavily regulated, your transactions will most likely be reported to tax authorities.

Some people think that’s a bad thing, others don’t mind. BUT, one other downside EVERYONE agrees is bad. Since the CEX has custody of your tokens, in extreme circumstances (however those are defined by the CEX) they can freeze your assets!

OK, so let’s recap. Centralized Exchanges make it simple to purchase cryptocurrencies through fiat on-ramps. They also don’t require you to move them anywhere or change any settings, regardless of what chain the token is on. So it’s very newbie friendly.

Centralized Exchanges are also highly regulated and most report your transactions to tax authorities. They retain custody of your tokens and, like a bank, have the ability to freeze your assets. One centralized authority over your money.

Ok, so what is a DEX? A Decentralized Exchange has a few similarities but many differences from CEXs. DEXs are also marketplaces for financial assets (cryptos). Most don’t operate with order books, however…

DEXs use what’s called Automated Market Makers (AMM). This automates the process of filling orders, so a buyer is NOT required for every seller, and vice versa. This is all handled by smart contract.

Basically, the money is held in a “Liquidity Pool” so whenever someone wants to buy or sell a token, they just draw the funds from that pool. Let’s use an analogy here…

Imagine it’s Halloween. There’s a giant jack-o-lantern bowl of candy. There’s two kinds of candy in it; Mini Snickers bars and Sour Patch kids. Standing behind the bowl there is a security guard (or a kid in a security guard costume…cuz…it’s Halloween).

Now, ANYONE that wants a Snickers bar can get one from that bowl, so long as they have a Sour Patch Kid to trade for it. If they have a box of Milk Duds instead, they have to go to the bowl across the street. This one only takes Sour Patch Kids.

Likewise ANYONE can have Sour Patch Kids if they have Snickers to trade. And the kid that looks like a security guard is the one who facilitates this trade. You hand him your one candy, he hands you back the other.

In this analogy the candy bowl is the AMM and the security guard kid is the smart contract. That’s how orders work on a DEX. There are a couple other key differences between CEXs and DEXs though.

DEXs are non-custodial. This means they DO NOT take custody of your tokens. You have to use a DeFi wallet (like Metamask) to connect to a DEX, and your tokens are automatically withdrawn from or deposited to the wallet. The DEX does not hold them.

This is good for a couple of reasons. First, that means a DEX cannot freeze your funds. The DEX never has your funds to begin with. Also, because a DEX is really just a smart contract, and it doesn’t hold your funds, DEXs don’t report any transactions to tax authorities.

The DEX is DE-centralized in this way. It doesn’t have control over your funds. Only you do. There are some downsides to this, however.

Few, if any, DEXs have a fiat on-ramp. They are less regulated and therefore unable to coordinate with banks and credit card companies to make this happen. That means you can only trade on a DEX with crypto.

Also, there is a learning curve. Since you have full custody of your tokens, YOU are responsible for ensuring that your DeFi wallet is connected to the proper network. Meaning, you have to be on the right blockchain (you can’t buy?#ETH?on the Binance chain).

And, because you have full custody of your tokens it is up to YOU to keep them safe. Meaning, if you allow your private keys (imagine these like your online banking password) to be compromised, there is little recourse.

So, to recap a DEX is a marketplace for cryptos that uses smart contracts and an automated market maker to facilitate trades. DEXs also do not take custody of your tokens, leaving you fully in charge of them and therefore do not report to tax authorities.

DEXs can be a bit complex to use, as you cannot use a credit card or fiat payments to transact on a decentralized exchange. You’ll also have to learn about the different blockchains since you have to connect to the appropriate network to use a DEX.

Due to these differences between CEXs and DEXs, just about everyone who is active in crypto and who holds several alt tokens uses BOTH. CEXs allow us to purchase stablecoins or bluechips with our fiat, and allow us to transfer our gains (when we have them) into fiat.

DEXs allow us to purchase altcoins that are not available on CEXs yet, and therefore to participate in a flourishing ecosystem of decentralized finance across multiple blockchains. CEX is the bank, DEX is the candy bowl.

Now for my *PRO TIPs on using CEXs and DEXs. I like to participate in a number of protocols on a number of chains, so I’ll typically start with a CEX that supports withdrawals to the chain I want to use. For example…

I’ll buy?$FTM?on?@BinanceUS?since I can withdraw it to the?#fantom?chain. I’ll buy?$AVAX?on?@coinbase?since I can withdraw it to?#avalanche?C-chain. I’ll buy?$MATIC?on?@cryptocom?since I can withdraw it to?#polygon.

THEN, when I have the native crypto I want on the chain I want to use, DEXs help me interact with the protocols I like. For example, on?#fantom?I’ll use?@SpookySwap?On?#avalanche?I’ll use?@traderjoe_xyz?Or on?#polygon?I’ll use?@QuickswapDEX

I hope this helped to disambiguate the difference between CEXs and DEXs for normies and noobs. For any crypto-natives that see this, feel free to share it with your normie friends and fam to help them understand your world better. Don’t forget to like, follow, share.