Blockchains produce tokens, either by mining them or minting them. In order to get people to participate in the network, they need a solution to exchange tokens for money or other tokens: enter exchanges. There are two types:
centralized exchanges (CEX)
decentralized exchanges (DEX)
CEXes
Examples: Coinbase, Binance
These are online trading platforms that match buyers and sellers via an order book (sellers are matched with buyers). They function the same way as online brokerage accounts, which is why they came first. A trusted party (the CEX) handles customers’ wallets for them, matches buyers & sellers and settles the transactions. They leverage centralized architecture to optimize the order book.
These are registered licensed, businesses which enable their customers to convert fiat money (like US dollars) to cryptocurrencies and vice-versa. They handpick which tokens can be bought. They are subject to their country’s law & regulations, and most countries impose Know-Your-Customer (KYC) rules, which in turn require CEXes to only allow identified customers to use their services. This prevents anonymous trading (and prevents certain people from using the exchange: the censorship problem).
CEXes are typically highly liquid, and allow customers to buy and sell at any time. Their business model is usually to collect a fee (~2%) on each transaction. Their major disadvantage is the custody problem: “not your keys, not your coins” : customers don’t actually control the tokens until they extract them from the exchange into a wallet they control.
DEXes
Examples: uniswap, sushiswap.
These are a newer and a more innovative concept: DEXes are autonomous financial protocols powered by smart contracts (typically on the ethereum blockchain and its derivatives). They enable crypto traders to swap one digital asset for another, with all transactions viewable on the blockchain.
They leverage Automated Market Maker methods, where the price automatically adjusts based on real-time selling and buying. This is typically implemented with liquidity pools (sellers sell to a pool, buyers buy from the pool) rather than an order book.
Since their code runs on public blockchains: anyone with a funded ethereum wallet can interact with them without limits and anonymously (only the address is public knowledge, not its owner’s identity).
They still only offer primitive trading techniques, and lack advanced ones like margin trades, limit orders, futures, etc... Their efficiency is significantly lower than CEXes since they run on blockchains, which is more expensive and slower than off-chain architectures. Their code being public doesn’t mean they’re necessarily safe: bugs can exist in the open that get uncovered over time. Despite all of this, their popularity is increasing.