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Today’s Lesson: Crypto Exchanges - Level: Beginner
Crypto exchanges are platforms where you buy and sell cryptocurrencies.
There are 2 main types of exchanges, centralized and decentralized. Some exchanges offer more advanced services like over-the-counter (OTC) trading, leverage trading, etc... However, in this lesson, we are going to focus on the basics. We’ll look at the differences between centralized vs. decentralized exchanges and the things to consider when using them.
Centralized Crypto Exchanges
Centralized crypto exchanges (CEXs) are centralized platforms that connect to and interact with blockchains to facilitate trading and serve as a middle man between buyers and sellers of crypto.
CEXs are divided into 2 sub-categories:
Crypto Only CEX - are exchanges that only trade cryptocurrencies. Most allow you to transition your fiat money to and from crypto directly into your bank account. Also, on/off ramps are offered that allow you to transfer your crypto assets off of the platform into your decentralized wallet. Examples include Coinbase, Gemini, Crypto.com, et al…
Crypto Offered CEX -are traditional stock exchanges or trading platforms that allow customers to purchase a limited number of cryptos. Typically, their offerings are limited to Bitcoin, Ethereum, Dogecoin, and a few other popular tokens. These exchanges do not offer on/off ramps to custody your crypto. Examples include Robinhood, Webull, and others.
Things to consider (Crypto Only CEX):
Beginner Friendliness - CEX offers the best way for you to dip your toe into crypto as a beginner. These platforms and apps are generally newbie-friendly. Also, CEXs provide the easiest way to on/off ramp your money in/out of crypto.
Accessibility - CEX crypto listings are limited to what’s been approved by the platform. Some offer a wide range of cryptos and while others focus only on vetted large-cap cryptocurrencies. Listed cryptos are not limited to a particular blockchain.
Regulation - CEXs are directly subjected to regulatory changes. In some cases, a country can and has outright banned buying/selling crypto. When this happens, the CEX generally has to shut down operations in that particular country.
Security - It’s always important to remember that cryptocurrencies are not backed by any central institution in most countries. El Salvador is the exception at the moment and there are few countries where this is being considered. This means that your crypto-assets do not have the same protections as your fiat in a bank. That said, many CEXs carry insurance protection to cover losses in the event of a hack. Some go a step further and hold most of the crypto assets in their custody offline in cold wallets. This makes your assets inaccessible to hackers and helps to ensure they can refund you if a hack did happen.
Fees - Most CEXs charge transaction fees and fees vary amongst them. The fees in most cases are generally a fixed percentage and are calculated by transaction type. Lower fees do not necessarily mean it will be the best CEX for you. So, take some time to compare and look at all of the items listed herein things to consider.
Liquidity - This simply means there’s enough money in the pot to allow you to buy and sell whenever you want. CEX’s with large trading volumes will generally have the best liquidity. Generally, the more popular the CEX, the more liquid it is. CEXs control what crypto they allow to trade on their platforms, this also means that they will manage liquidity as well. CoinMarketCap provides a great tool to quickly evaluate CEX liquidity and trade volume.
Decentralized Crypto Exchanges
Decentralized crypto exchanges (DEX) are smart contract-powered decentralized applications that facilitate trading between users of a particular blockchain. Opposite from their centralized counterparts, DEXs are purely peer-to-peer and code is law. Also, DEXs do not custody your crypto assets. Your assets remain in your wallet at all times. Examples include Uniswap, PancakeSwap, 1inch, SushiSwap, et al. You can only trade crypto on DEXs.
DEXs offer the ability to trade assets of 1 specific blockchain. For example, Uniswap is used to trade ETH and any Ethereum native tokens, and PancakeSwap is used to trade BNB and any Binance Smart Chain native tokens. Some DEXs do offer the ability to bridge tokens from 1 blockchain to be traded on another. However, this does require an intermediate understanding of blockchains.
Things to consider:
Beginner Friendliness - DEXs are not beginner-friendly and can be confusing for someone just starting in crypto. However, once you get the hang of navigating decentralized applications with your wallet it becomes pretty easy to use. Navigation is generally the same regardless of the blockchain.
Accessibility - Since you’re only able to trade crypto on a DEX, accessibility can be limited for beginners that do not have the knowledge needed to move crypto from a CEX to a decentralized wallet. DEXs generally list all cryptos on their native blockchain; there are some minor exceptions.
Regulation - DEXs are less susceptible to regulation. However, the foundations or decentralized autonomous organizations (DAOs - more on this on a later lesson) that maintain them are generally subjected to the laws of the country they are based in.
Security - DEXs do not offer any insurance when trading your funds. Anyone can list a token onto a DEX. Unlike CEXs, no one is responsible for vetting a token before it is listed. It is extremely important to do your homework on a token before trading for it on a DEX. You play a much larger role in maintaining your security.
Fees - DEX fees are generally lower than CEXs; the average fee across the top 3 DEXs is .28%. However, you will need to account for gas fees and potential slippage when trading on a DEX. Fees are paid to liquidity providers (see below).
Liquidity - Similar to CEXs, DEXs with high levels of trading typically have the most liquidity. DEXs manage liquidity using liquidity pools; they are smart contracts (code) that allow you to trade tokens even if there is not a buyer at the moment. Assets in the liquidity pool are provided by liquidity providers. These individuals are users like yourself that have placed their crypto assets into the DEX as collateral for trading in return for a portion of the fees collected by the DEX. Essentially, you can become the exchange. We will do a more thorough review of liquidity pools in another lesson.
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