Centralised vs decentralised exchanges

Where you trade crypto matters as much as what you trade. A centralised exchange looks and feels like a broker: an account, an order book, customer support. A decentralised exchange is a set of smart contracts you interact with directly from your own wallet. Each solves some problems and creates others — and the history of crypto includes painful lessons from both.

What you'll learn

• How centralised exchanges (CEXs) work — and the risk of trusting them with your funds
• How decentralised exchanges (DEXs) and automated market makers work
• Price impact, slippage, and fees on each
• The specific risks of DEX trading
• How to choose where to trade, and how much to keep there

1. Centralised exchanges (CEXs)

A centralised exchange is a company that holds customers' funds and matches their orders on an internal order book.

How it works

• You create an account, usually with identity verification (KYC).
• You deposit funds; the exchange holds custody of them.
• Orders are matched on the exchange's order book — market, limit, and stop orders work much as you learned in Foundation.

Advantages: deep liquidity on major pairs, familiar order types, fiat on- and off-ramps, customer support, and often derivatives such as perpetual futures.

The key risk — counterparty risk: your funds are only as safe as the exchange. In November 2022, the collapse of the FTX exchange left customers unable to withdraw their funds. The phrase "not your keys, not your coins" comes from exactly this risk.

2. Decentralised exchanges (DEXs)

A decentralised exchange runs on smart contracts. You trade directly from your own wallet, and the exchange never holds custody of your funds.

Automated market makers (AMMs)

Most DEXs don't use order books. They use liquidity pools: pairs of tokens deposited by users (liquidity providers). A formula sets the price based on the ratio of the two tokens in the pool.

A common design is the constant-product formula: the quantities of the two tokens multiplied together must stay constant. Buying one token removes it from the pool, making each additional unit more expensive.

Worked example: price impact

(Illustrative.) A pool holds 100 ETH and 300,000 USDC — an implied price of $3,000 per ETH. The constant product is 100 × 300,000 = 30,000,000.

You buy ETH with 30,000 USDC:

• New USDC in pool: 330,000
• ETH remaining: 30,000,000 ÷ 330,000 ≈ 90.91 ETH
• ETH you receive: 100 − 90.91 ≈ 9.09 ETH
• Average price paid: 30,000 ÷ 9.09 ≈ $3,300 — about 10% worse than the $3,000 quoted, before fees

Your trade was large relative to the pool, so it moved the price against you. This is price impact. DEX interfaces show it before you confirm — and let you set a slippage tolerance that cancels the trade if the price moves too far.

3. Comparing the two

4. Specific DEX risks

• Smart-contract risk — a bug or exploit in the contract can drain the pool.
• Fake tokens — anyone can create a token with the same name as a real one. Always verify the contract address from an official source.
• Front-running / MEV — bots can see pending transactions and trade ahead of them, worsening your price. Tight slippage settings limit this.
• Irreversibility — sending funds to the wrong address, or approving a malicious contract, usually can't be undone.

5. Choosing where to trade

1. Match the venue to the job. Active trading of major coins usually suits a reputable CEX; interacting with DeFi requires a DEX.
2. Limit exposure. Keep only the funds you need on any exchange; hold the rest in a wallet you control (next lesson).
3. Check liquidity on the specific venue before sizing a position (see Altcoins and stablecoins).
4. Know the jurisdiction. Some exchanges are not available — or not regulated — where you live.

Common beginner mistakes

• Keeping all funds on one exchange long term.
• Ignoring price impact on DEX trades that are large relative to the pool.
• Buying a token by name instead of verifying its contract address.
• Setting very high slippage tolerance "so the trade goes through".
• Forgetting gas fees, which can be large relative to small trades.

Key terms

Practice

1. For the exchange you use (or plan to), find: where it's regulated, whether it publishes proof of reserves, and its withdrawal limits.
2. On a DEX interface (without confirming a trade), check the quoted price impact for a small and a large swap in the same pool.
3. Find the official contract address for one token from the project's own website, and compare it with the token you'd find by searching its name.
4. Decide the maximum percentage of your crypto you'll keep on any exchange.

Quick recap

• CEXs hold your funds and run order books — convenient, but carry counterparty risk.
• DEXs let you trade from your own wallet via liquidity pools — no custody risk, but smart-contract, price-impact, and scam risks.
• Large trades in small pools suffer price impact; use slippage limits.
• Always verify token contract addresses.
• Keep only what you need on any exchange.