Centralized vs. Decentralized Cryptocurrency Exchanges

How do centralized and decentralized cryptocurrency exchanges differ? 

Centralized and decentralized cryptocurrencies are quite similar in ways but also have some major differences that are worth noting if you’re new to the cryptocurrency arena.

A cryptocurrency exchange is a renowned platform for buying and selling cryptocurrencies. Typically, exchanges are utilized by users to trade one cryptocurrency for another. For example, Bitcoin can be exchanged for Litecoin or purchased with fiat currency, such as the U.S. dollar. Each cryptocurrency exchange has its own laws and regulations, but they all allow access to the most popular coins. In addition, exchanges reflect the most recent market prices for their cryptocurrencies. The user may also convert cryptocurrencies back into U.S. dollars or another currency. The user can either leave the cryptocurrency in the user’s account as cash or withdraw it to their regular bank account.

Centralized Cryptocurrency Exchanges

A centralized cryptocurrency exchange is one platform where digital assets may be bought and sold. To oversee the transactions, users need to rely on a third party, and they have to protect the assets on behalf of both the seller and buyer. Furthermore, their transactions are not recorded on the blockchain. Therefore, such transactions necessitate the submission of personal information for verification purposes. In contrast, if the user is an organization, they must provide the exchange with their corporate details so it can authenticate their account.

Users can use centralized exchanges to trade fiat currency for cryptocurrencies (or vice versa). Additionally, users can use them to make transactions between two distinct cryptocurrencies. Despite the appearance that this covers all possible transaction kinds, there is still a demand for another sort of cryptocurrency exchange. Binance, Coinbase, and others are the most well-known centralized crypto exchanges. The most direct and secure cryptocurrency exchange in India, CoinDCX, is also a centralized exchange. 

Decentralized Cryptocurrency Exchanges

A decentralized cryptocurrency exchange, also known as a DEX, is comparable to a centralized cryptocurrency exchange, except that it does not involve a trusted third party. On this particular exchange, the blockchain holds all of the funds in circulation. In contrast to the IOU-based approach utilized by centralized cryptocurrency exchanges, these platforms facilitate peer-to-peer (P2P) trading, during which assets, proxy tokens, or an escrow mechanism are traded. Escrow services never take possession of the traded assets, and all business is conducted solely based on digital contracts and atomic swaps. Decentralized cryptocurrency exchanges like AirSwap and Uniswap are examples of this platform.

Centralized Exchange (CEX) Vs Decentralized cryptocurrency exchange (DEX)

Let’s dig deeper into the critical differences, advantages, and disadvantages of the different types of exchanges:

1. Security & Privacy

On a CEX, the user is less likely to encounter a scam coin, as centralized exchanges are more likely to vet the coins and tokens they list on their platform. Additionally, if the user forgets the password for their wallet, they can request the exchange to reset the password.

On the other hand, there is no recourse if a user is duped in the DEX ecosystem. Also, since the user owns the wallet, they cannot change the password if they forget their password and the seed phrase. Therefore, to safeguard the wallet, the user must select a series of random words that only they know.

2. Robustness

A CEX is more efficient and user-friendly. Centralized exchanges provide a smooth user experience with clear interfaces and are simple to join and trade on. Users can choose from various deposit and withdrawal methods, including cryptocurrencies, credit cards, and wire transfers, notwithstanding the requirement to pass KYC to use a cryptocurrency exchange. 

DEXes are more cumbersome, slower, and require more user experience to traverse. On decentralized exchanges, users can only trade cryptocurrency pairs. Therefore, the user must acquire cryptocurrency elsewhere if they wish to trade on a DEX. In addition, because transactions are processed on-chain, they can take several seconds to settle. However, when trading on a DEX, users retain custody of their assets.

3. Control

The users rely on the centralized exchange to fulfill their obligations and complete their cryptocurrency transfers. However, they lack control of their private key; thus, theoretically, the exchange might confiscate their assets.

With a decentralized exchange, the user retains complete control over their account. A DEX never takes possession of their cryptocurrency holdings. Instead, they remain in their wallet at all times and are therefore under their control.

4. Technological Maturity

CEXs are comparable to other extensive Internet services such as Facebook, Twitter, or Snapchat. However, they employ a more stable and user-friendly system that has considerably fewer problems.

Scalability is a significant issue with DEX technology. A blockchain network is dependent on the number of transactions it can process before reaching capacity. In May 2021, for instance, Ethereum processed 30 transactions per second.

5. Variety

The variety of trading pairs available on CEXs varies with every exchange. Some exchanges, such as Binance and KuCoin, are well-known for listing many altcoins, while others offer a much smaller selection. However, CEXs allow for the trading of cryptocurrencies against fiat currencies.

DEXs offer an extensive selection of crypto-to-crypto trading pairs. Since DEXs are permissionless, anyone can initiate a new market and supply liquidity for a new trading pair. However, users cannot trade cryptocurrencies against fiat currencies on decentralized exchanges; only stable coins are permitted.

6. Liquidity

Multiple users place specific orders based on market movements on centralized cryptocurrency exchanges, which increases their liquidity. Therefore, if an asset is in demand, consumers will buy or sell it accordingly. In addition, market makers contribute to the platform’s liquidity.

Due to the duration of order matching, decentralized networks have less liquidity than centralized platforms. Another critical factor is their lack of popularity.

Final Thoughts

Between centralized and decentralized exchanges, there is no apparent victor — it’s highly context-dependent. Although neither is superior, some traders may favor a CEX over a DEX. Certain coins are only available on DEXs, whereas CEXs give entry and exit points to cryptocurrencies and the traditional financial system. The user should keep the golden rule of cryptocurrency trading in mind: never invest money you cannot afford to lose. The user must decide on an exchange in accordance with what’s best for their own unique situation.

To level up and gain a deeper knowledge of all things related to the future of the cryptocurrency industry, check out the latest content in the Supra Academy section.

References

1. Pope, C. (2021, 15, Dec.). Centralized vs decentralized exchanges. CoinMarketCap.
2. Little, K. (2021, 8 July). Want to buy crypto? Here’s what to look for in a crypto exchange. NextAdvisor with TIME.
3. Reiff, N. (2021, 27 Aug.). What are centralized cryptocurrency exchanges?. Investopedia.

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