Exchange Vs DEX Vs Swap- An Overview and Comparison
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Blockchain introduced the idea of decentralization across many industries, including trade & finance. Previously, the only way to execute a trade was to use centralized exchanges like banks and financial institutions supervised by centralized bodies. A centralized trading platform takes a long time to complete the exchange process and approve the transactions. Now that everyone lacks time, a time-taking trading and exchange approach sounds unconvincing to people.
To overcome prevailing challenges in the traditional trading system, companies migrate their existing solutions to the blockchain. It helps them gain a competitive advantage and leverage high efficiency, transparency, and security. The core concept of blockchain strives to transfer the control and decision-making authority from a centralized system to the distributed networks, which is the best way to avoid manipulating records and fraudulent activities.
Since we are talking about the innovations brought by blockchain in the global trading structure, let’s understand it in detail while comparing decentralized technologies to traditional exchanges. In this regard, this insight will compare Centralized Exchanges, DEXs, and Swap.
- What is a centralized exchange?
- How does the centralized exchange work?
- What is a decentralized exchange?
- How does decentralized exchange work?
- What is a swap?
- How does swap works?
- Comparison: Exchange vs. Dex vs. Swap
What is a centralized exchange?
A centralized exchange refers to an online exchange platform where digital assets like Bitcoin (BTC), Litecoin (LTC), Ether (ETH), and even tangible assets are traded. As the name says, centralized exchanges are controlled by a central authority, which is the biggest difference between dex and Cex.
In essence, CEXs act as middlemen between the buyers and sellers involved in trading, where the return is generated through transaction fees and commission. Centralized exchanges have their own rules and regulations, but they work on a common goal to provide users access to the prevalent assets.
Trading volume is a crucial component for the success of a centralized exchange. The higher trading volume brings less volatility which eliminates risks of market manipulation that are likely to occur on a particular exchange. These centrally cleared and secure exchanges have helped major companies to launch feature-packed exchanges where people can trade, invest, and earn returns with decent liquidity. However, ever since blockchain has made decentralization feasible for trading platforms, there has been a clear shift of preference from centralized trading to decentralized trading.
How does the centralized exchange work?
Centralized exchanges are fully governed and controlled by a central authority, and traders need to trust this centralized authority to perform further trades. To easily understand how the exchange works, let’s take the example of stock exchanges. Today, most people know stock exchanges where shares are bought, sold, and exchanged at live prices.
A centralized exchange works like a stock exchange, but it facilitates buying, selling, and exchanging digital assets instead of shares. It requires traders to complete KYC (know your customer) verification to become registered users. The verification generally includes ID proof, name, address, and biometrics verification. Once verified, the exchange sends login details to the users to log in to their account, go through the rules, and start trading.
Also, note that users on centralized exchanges cannot exchange assets directly. The exchange takes over the custody of funds that users deposit, and it then issues an equivalent amount of IOUs to the traders that they can exchange only at the time of withdrawal. Here, we understand that IOUs play the role of smart contracts in centralized exchanges since it’s an informal document acknowledgment representing the debt one party owes to another.
On technical grounds, centralized exchanges adopt the Order Book Method to execute trades. Order book records the entire open orders to enable buying and selling of assets to traders. If a person wants to buy a particular asset, he must disclose the asset’s estimated price to the middle man involved in the exchange process.
Once that middleman finds someone whose request matches the buyer, it swaps the assets and completes the exchange between them. Order books have disadvantages, such as long waiting time for the exchange to be done and traders’ inability to cross-verify the transaction.
What is a decentralized exchange?
Decentralized exchange is built on the blockchain that allows people to trade their digital assets on a secure and transparent platform without any intermediates. DEXs has essential features of a centralized exchange, and it stands out for facilitating the trade of all the coins available virtually. It means traders do not need to be concerned about limited coin listing in DEXs.
In centralized exchanges, third parties look after the security and manage funds similar to banks and stock exchanges. DEXs substitute the role of these third parties with self-executing smart contracts to help simplify the exchange process.
How does decentralized exchange work?
Decentralized exchanges have evolved through multiple iterations. While first-generation DEXs use the order books, which work similar to centralized exchanges and stock markets, the latest decentralized exchanges implement a new mechanism called the Automated Market Maker. Let’s understand both methods to discover more.
Order book method
Order book compiles and maintains open orders to manage buying and selling of assets. If a person wants to buy a particular asset, he needs to send the asset’s estimated price to the smart contract. Once the smart contract finds someone whose request matches the buyer, it swaps the assets and gives them the asset he was willing to buy.
Whereas, if a person wants to sell his assets, he must submit the asset to the smart contract and wait until the contract finds suitable buyers for the assets kept under consideration. Either way, he can check out the order book, find a buyer, agree to his terms, and complete the process.
Order books are of two types:
1. On-chain order book: On-chain order-based decentralized exchange consists of nodes to maintain all the open orders. This method requires miners to validate each transaction.
2. Off-chain order book: Contrary to on-chain, the off-chain order-based decentralized exchange needs a centralized entity to host transactions’ records. However, the trading takes place on a decentralized peer-to-peer network. So, off-chain order book DEXs can be deemed as semi-decentralized.
Although many DEXs use the Order book method, it comes with certain limitations, such as the condition of depositing assets before the trade is initiated and trusting a centralized authority. This factor again helps decentralized exchanges to keep their momentum up.
Automated market maker method (AMM)
The automated market maker method is an algorithm used by renowned decentralized platforms like Uniswap and Sushiswap. It addresses the liquidity challenge of the traditional order book method and offers many other benefits.
With AMM, traders don’t need any third party to agree to their transaction terms. AMM-based exchanges do not require traders to wait long to find matching trades. Instead, they can make fast trades using a pool of funds that automatically execute trades based on certain parameters.
The trading pool n AMM is a liquidity pool that essentially follows the principle of demand and supply. Each time a trader buys a token, the liquidity pool gradually increases the price of that specific token. Each time a trader sells a token, the pool gradually decreases its price. This way, the exchange system becomes fully automated, eliminating counterparty and security risks.
What is a swap?
Swap facilitates the instant exchange of two non-native tokens between two unique blockchain protocols without the need of commencing the traditional crypto-to-fiat exchange or token migration. It allows users to swap tokens directly from the official private key wallet or the trading account. In-wallet exchange offers multiple benefits for the traders, such as non-custodial trading, on-chain exchange, faster transactions, and zero network fees.
Other reasons to use swap technology :
- Quickly swap to the growing asset.
- Shift to any Stablecoin from a volatile asset.
- Hedge against risks.
How does swap works?
Swap facilitates seamless crypto-to-crypto exchange with no intermediates involved in the process. Users do not need to adopt the traditional approach of converting native currencies to fiat and then buying the desired crypto. Converting tokens to fiat currencies is time-consuming and demands high from the users.
Taking note of these concerns, exchanges, wallets, and other blockchain-oriented trading platforms began offering the swap facility. Using a swap-enabled exchange platform, one can exchange any native token for a non-native token directly from the official crypto wallet. The swap requires users to add the total amount for which exchange is to be done and the desired trading pair, and this information is enough to perform swaps and exchange tokens from a different blockchain.
In a nutshell, swapping services provides users with simple, fast, affordable, and secure token or digital asset exchanges. Some even enhance their utility to offer cross-chain swaps. Learn in detail about cross-chain swaps here.
Few examples of centralized exchanges
- Coinbase Exchange
Few examples of decentralized exchanges
- Nash Exchange
- Tomo DEX
- Loopring Exchange
- Binance DEX
Few examples of swap-enabled exchanges
- change now
- Simple swap
Comparison: Exchange vs. Dex vs. Swap
Centralized Exchange (CEX)
Decentralized exchange (DEXs)
|A centralized entity (the platform itself) regulates the CEXs.||Uses smart contract technology with no centralized entity.||Same as a decentralized exchange, no one regulates swaps but smart contracts.|
|Verification is required which is done via KYC||Not required; trading is done anonymously||Not required|
|Under the control of third parties, exchanges are vulnerable to security breaches, data manipulation, and hacks.||DEXs offer robust security since a group of expert validators validates each transaction.||Swaps are equally secure as decentralized exchanges.|
|They are popular across traders.||They are increasingly popular and more prominent than centralized exchanges.||Traders are in love with the swap technology.|
|Exchange is accountable for security.||Users are responsible for the security.||Users are responsible for the security.|
|Centralized exchange is costly as third parties are involved in the exchange process.||It’s affordable with zero commission and transaction fees.||No network fees on trading account to trading account swap. Charges involved in a private key wallet to the trading account and private key wallet to private key wallet swap.|
|Available||Not available, except for the community forum.||Not available|
These exchanges- centralized exchange, decentralized exchange, and swap, carry their advantages and shortcomings. For example, centralized exchanges offer effective fund management, decentralized exchanges offer transparency, and swaps ensure quick token exchange. One can choose any of them according to their business need.
CEX, DEX, and swap are different, but they have a common goal of achieving high user satisfaction and promoting virtual trading. With increasing the demand for decentralized exchanges, at LeewayHertz, we offer blockchain development solutions for DEXs and decentralized trading platforms.
We provide services like redesigning your platform or building applications from scratch, crypto wallet development, AMM implementation, atomic swap, etc. AMM solution is currently popular among traders since it addresses liquidity challenges. If you need any blockchain development services, connect with our blockchain developers.
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