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You’ll need to understand the different types of cryptocurrency exchanges to use the Divi Defi platform effectively and maximize the additional rewards.

Crypto exchanges are crypto marketplaces where people buy, sell, and trade crypto coins and tokens. In Part 1 of the Divi DeFi Educational Series, we covered the differences between centralized finance (CeFi) and decentralized finance (DeFi). To expand on those principles, we need to examine the differences between the different types of cryptocurrency exchanges and the pros and cons of each.

Centralized Exchanges (CEX)

A centralized exchange is owned and operated by a for-profit company. These types of exchanges are generally known for their ease of use, have high liquidity, and are often where people starting their crypto journey make their first purchase or trade.

These exchanges have total control over everything that happens on their platform. They define the terms of service, choose which coins and tokens to offer their customers, set trading fees, and facilitate trades between user accounts by maintaining an order book system. Most importantly, the exchange is also responsible for the custody of user assets while they are held on that platform.

In order to trade, users must provide personal details and identification, and the exchange uses this info to perform KYC (Know Your Customer) to comply with AML (anti-money laundering) regulations. Centralized exchanges may also only be available to customers in certain countries or regions, and they may limit different platform features depending on the customer’s location.

While centralized exchanges are easy to use and offer some attractive features, users ultimately put their trust in a third party when they use these services, which comes with inherent risk. When customers sacrifice custody of their assets, it means they don’t own the private keys that give them control over their funds and are entirely reliant on the security of the exchange. Customer assets could be at risk if the exchange has a security breach or is hacked, and as mentioned in the previous article, the same can be said for users’ private information.

Decentralized Exchanges (DEX)

A decentralized exchange (DEX) is a peer-to-peer marketplace where crypto transactions are executed directly between traders with no middleman. Users connect their wallets and sign transactions via smart contracts that are settled directly on the blockchain. The user always maintains control of their own funds.

Decentralized exchanges generally only offer trading between cryptocurrency tokens. Since they don’t offer fiat on-ramps and don’t typically need to be KYC-compliant, users aren’t required to provide identification to use one. This allows the user to remain in control of their private information without trusting a third party.

Since these exchanges are not run by any central authority, they are available to anyone with an internet connection, even in places where solid banking infrastructure is unavailable. These exchanges also offer a wider range of trading pairs since no company is deciding which coins and tokens they wish to support or collecting listing fees. Anyone can mint an Ethereum-based token and create a liquidity pool for it.

Automated Market Maker (AMM) DEXs, like the one the Divi Defi protocol will use, were created to solve liquidity issues and provide an earning opportunity that does not exist on centralized exchanges. Market participants who provide liquidity to a trading pair can earn additional rewards in the form of liquidity pool (LP) tokens.

Because trading on a DEX is peer-to-peer, users don’t pay trading fees to an exchange. Instead, users pay a trading fee which is split between the liquidity providers. While the trading fee is usually very low, it is important to note that the gas fees on the Ethereum network, where many DEXs operate, can often be much higher than the trading fees themselves. The speed of transactions can also vary based on network congestion.

Decentralized exchanges offer some unique benefits and earning opportunities but are usually geared toward advanced traders. If users are not diligent about safely storing their keys or paying close attention to the transactions they are signing, they can easily lose their funds. There are typically no “forgot password” links or customer support team to help you recover from a mistake on a decentralized exchange. The personal responsibility that comes with controlling your funds is paramount and falls entirely on the user’s shoulders.

CEX vs. DEX

There are many clear technical and privacy-centric advantages to the vision of DeFi, shaping the future of finance.