Exchange Vs DEX Vs Swap- An Overview and Comparison
Native capabilities of blockchain, such as its decentralized nature, tamper-proof technology, and the ability to record transactions in a peer-to-peer network, have proved how this technology can revamp the global trading and exchange structure. Though the advent of new technologies, advanced computer programs, and high-speed internet access could improve the traditional trading systems to a major extent, yet investors continued to encounter certain problems until blockchain brought real technological advancement. Blockchain introduced the concept of decentralization in trading, while traditional exchanges are centralized platforms for they are governed by centralized bodies.
A centralized trading platform requires days to complete the exchange process and to approve the transactions. When everyone is too busy nowadays, such a time-taking approach sounds unconvincing.
To resolve these pain points, trading markets are increasingly adopting blockchain integration into their existing platforms to gain a competitive advantage and bring high efficiency, transparency, and accuracy across trading exchanges. 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 means to avoid manipulation of records and fraud.
As 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
- Summing Up
What is a Centralized Exchange?
A centralized exchange refers to online platforms that facilitate the purchase and sale of digital assets like Bitcoin (BTC), Litecoin (LTC), Ether (ETH), and even tangible assets like gold and silver. As the name indicates, centralized exchanges are fully controlled and regulated 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 ought to trust this authority to perform trades. To easily understand how does the exchange works, let’s take the example of stock exchanges. Most people today 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.
Traders are required to complete KYC (know your customer) verification to become registered users on any exchange. 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 in their preferred assets or currencies.
Also, note that CEX users do not exchange assets directly with each other. Alternatively, the exchange takes over the custody of funds that users deposit. 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 a popular use case of blockchain that allows people to buy and sell their digital assets with one another on a secure and transparent platform. DEXs include essential features of a centralized exchange, and it even stands out for facilitating trade of all the coins available virtually. It means that traders do not need to be concerned about limited coin listing in DEXs as they do in a centralized exchange.
In centralized exchanges, third parties oversee the security and project the funds similar to banks, stock exchanges. Whereas DEXs substitute the role of these third parties with precoded smart contracts to help users conveniently execute trades.
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. In this context, let’s understand both methods.
Order book method
Order book compiles and maintains open orders to enable buying and selling of assets to traders. 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 the buyer the asset he was willing to buy.
On the other hand, if a person wants to sell his assets, he will submit the asset to the smart contract and wait till 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 primarilly address the challenge of liquidity of order book methods and offers many other benefits. In AMM method, traders don’t need any third party to agree to their transaction terms. Also, they don’t require waiting long to find matching trades. Instead, they can make fast trades using a pool of funds that automatically execute trades based on certain parameters.
Here, the trading pool 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. Whereas each time a trader sells a token, the pool gradually decreases its price. This way, the exchange system operates/goes fully automated, which eliminates counterparty and security risks.
What is a Swap?
Swap facilitates the instant exchange of two different tokens that belong to two unique blockchain protocols without the need of commencing the traditional crypto-to-fiat exchange or token migration. It allows users to swap tokens/assets directly from the official private key wallet or the trading account itself. In-wallet exchange offers multiple benefits for the traders such as non-custodial, on-chain exchange, faster transactions, and zero network fees.
Wallet users love the swap technology for reasons like:
- Quickly swap to the growing asset.
- Shift to any stablecoin from a volatile asset.
- Hedge against risks.
How Does Swap Works?
As added above, swap facilitates seamless crypto-to-crypto exchange benefits instead of time-taking and costly converting any currency to fiat to use the fiat to buy the desired coin. We must agree that this process of exchanging tokens to fiat currencies is time-taking and demands charges more than once while someone exchanges the token.
Taking all these drawbacks into consideration, exchanges, wallets, and other blockchain-oriented trading platforms began offering swap facilities. Using this, anyone can easily convert their tokens for another directly from their custodial or non-custodial wallet. The swap requires users to add the amount for which exchange is to be done along with desired trading pair. This information is enough to instantly perform swap and get tokens converted into a completely different native token.
In a nutshell, swapping services provides users with simple, fast, affordable, and secure token or digital asset exchanges. Some even go the extra mile to allow users to perform cross-chain swaps. Learn in detail about cross-chain swaps here.
Few Examples of Centralized Exchanges
- Trader Joe
Few Examples of Decentralized Exchanges
- Nash Exchange
- Tomo DEX
- Loopring Exchange
- Binance DEX
Few Examples of Swap-enabled Exchanges
- change now
- Simple 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|
Note that all three exchanges; centralized exchange, decentralized exchange, and swap have their pros and cons. For example, centralized exchanges bear the whole responsibility of managing your funds, decentralized exchanges offer transparency, and swaps ensure quick token exchange. Based on priority and convenience, people can choose one among them and perform trades.
As evident, CEX, DEX, and swap are different, but they all have one common goal to achieve high user satisfaction and promote the trend of virtual trading. As the demand for decentralized exchanges has increased over the years, at LeewayHertz, we are offering blockchain development solutions for DEXs and decentralized trading platforms. We provide solutions like redesigning your platform or building applications from scratch, crypto wallet development, AMM implementation, atomic swap, etc. AMM is currently popular among traders since it addresses liquidity challenges. If you need any blockchain development services related to decentralized exchanges, talk to our blockchain experts.
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