DEX vs CEX: Choosing the Best Solution for Your Crypto Exchange

Maciej Zieliński

08 Nov 2021
DEX vs CEX: Choosing the Best Solution for Your Crypto Exchange

What are the differences between DEX and CEX? Which one suits your needs and business assumptions best? Read this article before you make that crucial decision.

In the article you learn about:

  • Different types of crypto exchanges
  • What is a centralized exchange?
  • Pros and cons of centralized exchanges
  • How does decentralized exchange work?
  • Liquidity pools and Automatic Market Maker
  • Pros and cons of decentralized exchanges

Crypto Exchanges

The cryptocurrency exchange is an indispensable part of cryptocurrency trading, which may be considered as one of the most important financial trends of this century. Hence more and more investors are becoming interested in launching their own exchange. The fundamental decision that has to be made at the begging is choosing the model of crypto trading that will meet our requirements. 

In this article, we'll take a closer look at centralized and decentralized exchanges, which will hopefully enable you to examine which of them is right for your project in the crypto space.

Centralized Exchange
Centralized Exchange

Centralized Exchange

Most big cryptocurrency exchanges you know are probably centralized. Coinbase, Binance, BKEX, or Upbit - you are familiar with them. Thanks to higher liquidity and lower transaction fees they remained the first choice of crypto traders for a long time.

Times have changed and players such as decentralized exchange Uniswap or Sushi Swap have gained significant importance in the crypto market. Yet, in many cases, centralized exchanges still remain the most suitable solution. What's their backbone?

Centralization of an exchange

Centralization of the exchange essentially means that each trade there takes place with a centralized intermediary. The centralized exchange has its order book, where every order is recorded and validated. All the data is stored and exchanged between exchange servers. Additionally, transactions and user information go through a centralized security process.

To access the exchange, users have to sign up by providing their bank details and personal data. This is the part of KYC and AML practices, which aim to prevent money laundering and have to be followed by every centralized exchange. 

Buying cryptocurrencies on a centralized exchange

Trading on centralized exchanges generally seems simple. You just need to choose coins and confirm the transaction. The exchange will show the funds you acquired in your account. Then you can trade them for other digital assets. The price of each coin on the site is based on an order book.

However, users don't really hold their funds. The exchange works here as a custodian of the customer’s funds. Furthermore, trades don't occur on the blockchain. Instead, they take place only within the exchange's database.

Centralized exchange - pros and cons
Centralized exchange - pros and cons

Pros of Centralized Exchanges

User-friendliness

Generally, centralized exchanges have a more user-friendly platform. They give users easy and uncomplicated access to crypto trading. This is especially relevant for crypto newcomers.

High liquidity

Since the whole process doesn't take place on a blockchain, the network nodes don't have to be updated in real-time, hence trading speed is usually much higher than on DEX.

Lower transaction fees

The trading fee on CEX is fixed, and they tend to be lower than on decentralized exchanges for the same reason as stated above.

Trading with fiats

Unlike DEXs, centralized exchanges allow users to buy crypto for fiat currencies.

Cons of Centralized Exchanges

More legal regulations

Centralized exchanges are limited by strict government requirements. For example, high standards of the identity verification process have to be respected.

Centralized entity

From a technical point, when you deposit funds on a centralized exchange, you lose control over it. The exchange puts your funds into integrated wallets controlled by it.

Additionally, CEXs extract users' private keys. They will no longer be your keys. Therefore, if you want to withdraw your money, the exchange has to sign the transaction on your behalf.

This is an important reason why many traders migrate to decentralized exchanges.

Risk of leaking private user data

Due to KYC procedures, crypto users provide extensive data. As such information is fragile, a security dilemma is present even before one starts trading. This may lead to the lack of users’ trust, especially when we talk about smaller, less-known exchanges.

Decentralized Exchange
Decentralized Exchange

Decentralized Exchange

In many ways, decentralized exchanges are similar to centralized ones. However, the differences are more than substantial. In decentralized exchanges, trade essential relies on a blockchain (most often Ethereum or the Binance Smart Chain). Trading between users is conducted using smart contracts - orders are executed on-chain. As a result, the exchange doesn't take control of users' assets during the entire process.

Cross-chain exchanges are a very promising novelty on the DEX market. Yet, most of them operate only on one blockchain - most often Ethereum or the Binance Smart Chain.

How can a decentralized exchange handle trading?

How DEX handles trading
How DEX handles trading

On-chain order book

There are decentralized exchanges where every transaction is written into a blockchain. This means that every order, as well as cancellation or alteration, is handled on-chain.

Without a doubt, this is the purest approach to decentralization. There is absolutely no third party involved at any stage of trading. Everything is extremely transparent. Unfortunately, there are vital downsides as well.

The on-chain order book is far less practical than the other two options. Firstly, because every node on the blockchain records the order, placing it requires paying a fee. Furthermore, users have to wait until the miner adds necessary data to the chain. This translates to high costs and poor liquidity.

Off-chain order book

Off-chain order books are a bit more centralized than their counterparts. But they are also far more practical. In this model, orders are hosted elsewhere and only the final transaction is settled on the blockchain. Moreover, you can still benefit from non-custodial storage.

As orders aren't stored on-chain, this approach is faster and less costly. Furthermore, it helps a better liquidity of trades to be achieved. However, it can encounter some of the security issues typical for CEXs.

Trading pairs 

Let’s use the example of Ether and Bitcoin to describe how trading pairs work in the order book model on DEX

If users want to trade their ETH for BTC, they need to find another trader willing to sell BTC for ETH. Furthermore, they need to agree on the same price. 

While in the case of popular cryptocurrencies and tokens, finding a trading pair shouldn’t be a problem, things get a bit more complicated when we want to trade more alternative assets. 

The vital difference between order books and automatic market makers is that the second one doesn’t require the existence of trading pairs to facilitate trade.

Automatic Market Maker AMM

Automated Market Maker (AMM) is a decentralized exchange protocol that relies on smart contracts to set the price of tokens and provide liquidity. In an automated market makers' model, assets are priced according to a pricing algorithm and mathematical formula instead of the order book used by traditional exchanges.

Essentially, they are autonomous trading machines that replace traditional order books with liquidity pools run by algorithms. According to many, it was the development of AMM that enabled the mass adoption of decentralized exchanges.

Dentralized exchange - pros and cons
Dentralized exchange - pros and cons

Pros of Decentralized Exchanges

No KYC

Most of the DEXs don’t have to follow KYC and AML requirements, because they don’t intermediate in transactions between parties. That’s why it’s often more convenient to build your own DEX than CEX. 

No third parties involved

The basic idea behind decentralized trading is removing third-party providers. All transactions take place in a peer-to-peer or peer-to-contract model. 

Full control of your assets

A decentralized exchange doesn't hold the user's assets or private keys. Therefore funds are under the user's control at every stage of trading.

More diversified crypto assets

On the DEX platform, trades of tokens that aren’t listed on CEXs are possible.

Cons of Decentralized Exchanges

Trading volume

The volume traded on CEXs is still much higher than that on DEXs. Liquidity is lower as well.

Higher fees

This is not an absolute standard, but when it comes to trading fees CEXs often offer better prices.

Convenience

A decentralized exchange is less user-friendly than a traditional one.

DEX vs CEX
DEX vs CEX

Developing DEX vs CEX

Crypto space develops at a tremendous speed, continuously bringing new possibilities. The number of people interested in crypto investments increases every day; hence the popularity of both decentralized and centralized exchanges has recently grown significantly. You need to bear this in mind when deciding to launch your crypto exchange.

Launching a crypto exchange requires not only experience of blockchain developers’ fluently using blockchain protocols but also a solid and well-planned business strategy. That's why choosing a technology partner with previous experience with both blockchain development and business consulting in the crypto field might be the optimal solution.

Do you want to gain more first-hand knowledge regarding building crypto exchanges? Don't hesitate to ask our professionals who will be happy to answer your questions.

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How NOT to Create a DAO: Common Pitfalls You Should Avoid

Kajetan Olas

27 Dec 2024
How NOT to Create a DAO: Common Pitfalls You Should Avoid

Decentralized Autonomous Organizations (DAOs) represent a fundamental shift in how communities, companies, and initiatives can coordinate efforts, funds, and decisions on the blockchain. By leveraging transparent smart contracts and on-chain governance mechanisms, DAOs aim to distribute authority, reduce overhead, and foster a more democratic decision-making process. However, building a successful DAO isn’t just about cutting-edge tech or grand ideas—it also requires a clear vision, well-crafted governance rules, and a strategically engaged community.

In this article, we’ll take a counterintuitive approach by highlighting how not to create a DAO. By focusing on common pitfalls—from legal oversights to governance missteps—we can better understand what truly contributes to a thriving, sustainable DAO. This perspective aligns with the importance of recognizing cognitive biases, such as insensitivity to base rates and the conjunction fallacy, which often lead enthusiastic founders to overlook real-world data and complexity. Avoiding these traps can be the difference between launching a resilient DAO and watching an ambitious project crumble under misaligned structures or unmet expectations.

2. Missing the Governance Threshold Mark

Governance Thresholds Gone Wrong

Governance thresholds dictate how many votes or what percentage of voting power is needed to pass a proposal within a DAO. Striking the right balance here is crucial. Thresholds that are set too high can stifle progress by making it nearly impossible for proposals to succeed, effectively discouraging member participation. On the other hand, thresholds that are too low can lead to frivolous proposals or constant voting spam, making governance more of a burden than a benefit.

When designing your DAO’s thresholds, consider:

  • Community size and engagement levels: Larger communities might handle higher thresholds more comfortably, while smaller groups may benefit from lower requirements to encourage active participation.
  • Type of proposals: Operational decisions may need a lower threshold, whereas critical changes (such as tokenomics or treasury management) often require more consensus.
  • Voter fatigue: The more frequently members are asked to vote—and if it’s too easy to put forward proposals—the greater the risk of apathy or disengagement.

Over-Complex vs. Over-Simplified Governance

It’s tempting to either pile on complicated governance rules or oversimplify them to keep decision-making quick. However, both extremes can be problematic. Simplicity in governance is key to enhancing clarity and participation. Overly complex smart contracts and procedural layers can dissuade newcomers from getting involved, while an oversimplified model might fail to address potential conflicts or security vulnerabilities.

Some issues to watch out for:

  • Complex Smart Contracts: More code means more potential bugs and greater difficulty in auditing or updating governance logic.
  • Opaque Voting Processes: If members can’t easily understand how votes are tallied or how proposals are introduced, engagement drops.
  • Excessive Centralization in “Simple” Models: In trying to streamline governance, some DAOs inadvertently concentrate power in the hands of a few decision-makers.

Ultimately, aiming for a balanced governance framework—one that is easy enough for members to participate in but comprehensive enough to protect the DAO from abuse—is central to avoiding the pitfalls of governance threshold mismanagement.

3. Underestimating Legal and Regulatory Aspects

Legal Wrappers and Compliance

Building a DAO without considering legal and regulatory frameworks is a common recipe for disaster. While decentralization is a powerful concept, it doesn’t absolve projects from potential liabilities and compliance obligations. Assigning your DAO a formal legal wrapper—whether it’s a foundation, a cooperative, an LLC, or another entity type—can help mitigate personal risks for contributors and align your organization with existing regulatory regimes.

Failing to think through these details often leads to:

  • Personal Liability for Founders: Without a proper legal entity, core contributors might become personally responsible for any legal disputes or financial mishaps involving the DAO.
  • Regulatory Crackdowns: Governing bodies worldwide are actively monitoring DAOs for compliance with securities laws, anti-money laundering (AML) regulations, and tax obligations. Ignoring these can lead to penalties, fines, or forced shutdowns.

Non-Existent or Inadequate Documentation

Equally problematic is the lack of clear documentation outlining the DAO’s legal structure and operational protocols. From voting procedures to treasury management, every aspect of the DAO’s lifecycle should be properly documented to reduce ambiguity and help new members understand their responsibilities. Inadequate documentation or outright neglect can create:

  • Confusion Over Roles and Responsibilities: Without explicit definitions, it’s easy for tasks to fall through the cracks or for disagreements to escalate.
  • Inability to Enforce Rules: DAOs rely on both smart contracts and social consensus. Formalizing rules in documentation helps ensure consistent enforcement and prevents unwelcome surprises.

In short, underestimating the legal dimension of DAO creation can derail even the most innovative projects. By proactively addressing legal and regulatory considerations—and maintaining thorough documentation—you not only protect core contributors but also fortify trust within your community and with external stakeholders.

Overlooking Community Building

The Importance of Community Engagement

A DAO, at its core, is nothing without an active and supportive community. Driving grassroots enthusiasm and participation is often the deciding factor between a thriving DAO and one that fizzles out. Yet, it’s surprisingly easy to underestimate just how vital it is to nurture community trust and engagement—especially during the early stages.

Some common pitfalls include:

  • Treating Community Members as Passive Observers
    Instead of viewing your community as a dynamic force, you might slip into a one-way communication style. This discourages members from taking initiative or contributing fresh ideas.
  • Lack of Clear Roles and Channels
    Without well-defined roles and open communication channels—like forums, Discord servers, or governance platforms—members can feel confused about where to participate or how to add value.
  • Ignoring Early Feedback
    In a DAO, the “wisdom of the crowd” can be a powerful asset. Overlooking or trivializing user feedback can lead to missed opportunities for innovation and improvement.

Failing to Incentivize Properly

Well-structured incentives lie at the heart of any successful DAO. Whether you’re offering governance tokens, staking rewards, or recognition badges, these incentives must be aligned with the DAO’s long-term goals. Misalignment often causes short-sighted behavior, where participants chase quick rewards rather than contributing meaningfully.

  • Overemphasis on Token Speculation
    If the primary draw for community members is the promise of quick token price gains, you risk attracting speculators instead of builders. This can lead to fleeting participation and sell-offs at the first sign of trouble.
  • Neglecting Non-Monetary Rewards
    Recognition, social standing, and meaningful collaboration can be just as powerful as financial incentives. When a DAO fails to provide pathways for skill development or leadership, member engagement wanes.
  • Cognitive Bias Traps
    Biases such as the conjunction fallacy can mislead founders into believing that if multiple positive outcomes are possible (e.g., rising token prices, active participation, mainstream adoption), then all those outcomes will inevitably happen together. This wishful thinking can blind DAOs to the need for thoughtful, data-driven incentive models.

To avoid these pitfalls, DAO creators must actively foster a culture of transparency, collaboration, and mutual respect. By setting clear expectations, leveraging diverse incentive structures, and consistently involving community feedback, you ensure members are motivated to contribute more than just their votes—they become co-creators in the DAO’s shared vision.

5. Ignoring Technical Considerations

Token Standards and Governance Frameworks

A solid technical foundation is essential when you create a DAO, particularly if it involves on-chain governance. Selecting the appropriate token standards and governance frameworks can significantly impact your DAO’s security, efficiency, and scalability.

Some pitfalls to watch out for include:

  • Choosing Incompatible Token Standards
    If your DAO relies on a token that isn’t easily integrated with governance contracts or lacks upgradeability, you might face roadblocks when implementing new features or patching vulnerabilities.
  • Underestimating Smart Contract Complexity
    Even “simple” governance tokens can hide complex logic behind the scenes. Overlooking these complexities may result in bugs, lockouts, or exploits that harm the DAO’s reputation and finances.
  • Ignoring Off-Chain vs. On-Chain Dynamics
    Governance strategies often combine on-chain decisions with off-chain discussions (e.g., using platforms like Discord or forums). Failing to synchronize these two spheres can fracture community engagement and hamper decision-making.

Poor Architecture and Security

Robust security isn’t just about preventing hacks—it's about building an architecture that can adapt to evolving threats and changing community needs.

Key oversights include:

  • Inadequate Auditing
    Smart contracts require thorough reviews, both automated and manual. Rushing to mainnet deployment without proper audits can lead to major losses—financial, reputational, or both.
  • No Contingency Plans
    If a vulnerability is discovered, how will you respond? Lacking emergency procedures or fallback governance mechanisms can leave a DAO paralyzed when critical decisions must be made quickly.
  • Over-Engineered Solutions
    While security is paramount, over-complicating the DAO’s architecture can create unintended vulnerabilities. Keeping your setup as simple as possible reduces attack surfaces and makes it easier for community members to understand and trust the system.

In short, technical considerations form the bedrock of a functional DAO. Choosing appropriate token standards, thoroughly auditing contracts, and designing for both present-day and future needs are non-negotiable steps in avoiding costly pitfalls.

Best Practices and Lessons

When studying successful DAOs, certain themes emerge time and again. According to Aragon the most robust DAOs share a commitment to simplicity, iteration, and transparent governance. Instead of rolling out overly sophisticated models from day one, they evolve and adapt based on community feedback and real-world performance.

Here are a few best practices worth emulating:

  • Iterative Approach to Governance
    Start small and build up. Launch a Minimal Viable DAO (MVD) to test voting processes, incentive mechanisms, and proposal management. Gather community feedback and refine before taking bigger steps.
  • Simple, Transparent Rules and Processes
    Ensure proposals are easy to understand and that the voting process is accessible to all token holders. Overly complicated frameworks can dissuade new members from participating.
  • Clear Roles and Shared Responsibilities
    Define contributor and community member roles early on. Whether you rely on working groups, committees, or elected leaders, clarity prevents power vacuums and fosters collaboration.
  • Open Communication and Education
    From Discord channels to public documentation, keep conversation and learning at the heart of your DAO. Encourage members to ask questions, propose improvements, and take leadership roles.

Academic Perspectives

Beyond practical experience, a growing body of research offers theoretical insights that can strengthen DAO governance. The discusses emerging patterns in DAOs, including how incentives and on-chain rules interact with off-chain social dynamics. By examining these findings, DAO creators can better anticipate challenges—like voter apathy, whale influence, or collusion—and integrate solutions from the outset.

Incorporating academic perspectives can help:

  • Validate Governance Assumptions
    Empirical data and rigorous analyses can confirm or challenge the assumptions behind your DAO’s architecture, preventing costly mistakes.
  • Stay Ahead of Regulatory and Social Shifts
    Academics often explore how upcoming policies or societal trends might impact DAOs, offering a forward-looking lens that day-to-day builders might miss.
  • Establish Credibility
    Aligning your DAO’s structure and operations with recognized research signals professionalism and thoroughness, potentially attracting more serious contributors, partners, and investors.

Conclusion

As you can see, creating a DAO involves more than just deploying a smart contract and distributing tokens. By examining these common pitfalls—from poor governance thresholds to inadequate legal structures, from neglecting community engagement to disregarding technical complexities—you gain a clearer picture of what not to do when you set out to create a DAO. Failing to address these areas often leads to compromised security, stalled decision-making, regulatory headaches, or outright community collapse

At Nextrope, we specialize in tailored blockchain and cryptocurrency solutions, including DAO creation and tokenomics design. If you’re looking to avoid these common pitfalls and build a thriving DAO that stands the test of time, feel free to contact us or explore more resources on our blog.

Quadratic Voting in Web3

Kajetan Olas

04 Dec 2024
Quadratic Voting in Web3

Decentralized systems are reshaping how we interact, conduct transactions, and govern online communities. As Web3 continues to advance, the necessity for effective and fair voting mechanisms becomes apparent. Traditional voting systems, such as the one-token-one-vote model, often fall short in capturing the intensity of individual preferences, which can result in centralization. Quadratic Voting (QV) addresses this challenge by enabling individuals to express not only their choices but also the strength of their preferences.

In QV, voters are allocated a budget of credits that they can spend to cast votes on various issues. The cost of casting multiple votes on a single issue increases quadratically, meaning that each additional vote costs more than the last. This system allows for a more precise expression of preferences, as individuals can invest more heavily in issues they care deeply about while conserving credits on matters of lesser importance.

Understanding Quadratic Voting

Quadratic Voting (QV) is a voting system designed to capture not only the choices of individuals but also the strength of their preferences. In most DAO voting mechanisms, each person typically has one vote per token, which limits the ability to express how strongly they feel about a particular matter. Furthermore, QV limits the power of whales and founding team who typically have large token allocations. These problems are adressed by making the cost of each additional vote increase quadratically.

In QV, each voter is given a budget of credits or tokens that they can spend to cast votes on various issues. The key principle is that the cost to cast n votes on a single issue is proportional to the square of n. This quadratic cost function ensures that while voters can express stronger preferences, doing so requires a disproportionately higher expenditure of their voting credits. This mechanism discourages voters from concentrating all their influence on a single issue unless they feel very strongly about it. In the context of DAOs, it means that large holders will have a hard-time pushing through with a proposal if they'll try to do it on their own.

Practical Example

Consider a voter who has been allocated 25 voting credits to spend on several proposals. The voter has varying degrees of interest in three proposals: Proposal A, Proposal B, and Proposal C.

  • Proposal A: High interest.
  • Proposal B: Moderate interest.
  • Proposal C: Low interest.

The voter might allocate their credits as follows:

Proposal A:

  • Votes cast: 3
  • Cost: 9 delegated tokens

Proposal B:

  • Votes cast: 2
  • Cost: 4 delegated tokens

Proposal C:

  • Votes cast: 1
  • Cost: 1 delegated token

Total delegated tokens: 14
Remaining tokens: 11

With the remaining tokens, the voter can choose to allocate additional votes to the proposals based on their preferences or save for future proposals. If they feel particularly strong about Proposal A, they might decide to cast one more vote:

Additional vote on Proposal A:

  • New total votes: 4
  • New cost: 16 delegated tokens
  • Additional cost: 16−9 = 7 delegated tokens

Updated total delegated tokens: 14+7 = 21

Updated remaining tokens: 25−21 = 425 - 21 = 4

This additional vote on Proposal A costs 7 credits, significantly more than the previous vote, illustrating how the quadratic cost discourages excessive influence on a single issue without strong conviction.

Benefits of Implementing Quadratic Voting

Key Characteristics of the Quadratic Cost Function

  • Marginal Cost Increases Linearly: The marginal cost of each additional vote increases linearly. The cost difference between casting n and n−1 votes is 2n−1.
  • Total Cost Increases Quadratically: The total cost to cast multiple votes rises steeply, discouraging voters from concentrating too many votes on a single issue without significant reason.
  • Promotes Egalitarian Voting: Small voters are encouraged to participate, because relatively they have a much higher impact.

Advantages Over Traditional Voting Systems

Quadratic Voting offers several benefits compared to traditional one-person-one-vote systems:

  • Captures Preference Intensity: By allowing voters to express how strongly they feel about an issue, QV leads to outcomes that better reflect the collective welfare.
  • Reduces Majority Domination: The quadratic cost makes it costly for majority groups to overpower minority interests on every issue.
  • Encourages Honest Voting: Voters are incentivized to allocate votes in proportion to their true preferences, reducing manipulation.

By understanding the foundation of Quadratic Voting, stakeholders in Web3 communities can appreciate how this system supports more representative governance.

Conclusion

Quadratic voting is a novel voting system that may be used within DAOs to foster decentralization. The key idea is to make the cost of voting on a certain issue increase quadratically. The leading player that makes use of this mechanism is Optimism. If you're pondering about the design of your DAO, we highly recommend taking a look at their research on quadratic funding.

If you're looking to create a robust governance model and go through institutional-grade testing please reach out to contact@nextrope.com. Our team is ready to help you with the token engineering process and ensure that your DAO will stand out as a beacon of innovation and resilience in the long term.