Centralized vs.Decentralized Exchanges

Nov 17, 2021 03:35 PM ET
Centralized vs.Decentralized Exchanges

Cryptocurrency exchanges are online marketplaces that allow users to trade cryptocurrencies for other assets, such as digital and fiat currency. 

There are numerous technical aspects involved in cryptocurrency trading, all of which happen behind the scenes throughout each transaction. For example, six confirmations are needed before a Bitcoin routing trade is completed.

A new breed of decentralized exchanges is emerging, taking a different approach to trading than the long-established, centrally-run exchanges. So, what's the difference between them, and which is best for you?

Centralized exchanges (CEXs)

CEXs are crypto marketplaces that facilitate the buying and selling of digital assets under the control of a central authority. The buyer and seller must rely on a third party to keep an eye on the transaction and protect their assets throughout their holding on the platform.

In addition, transactions aren't recorded on the blockchain. Such transactions necessitate the submission of personal information for the purposes of verification. However, if you're a business, you'll be required to furnish the platform with your firm details in order to validate your account.

CEXs serve as a trusted middleman, facilitating trading and safeguarding tokens. The exchange keeps track of their accounts, makes transactions easier, and offers additional services to support customers. New currencies may also be reviewed and vetted by these exchanges before being included in the network.

Pros and cons of CEXs

Pros

Friendly user experience: CEXs have user-friendly interfaces, which are easier to navigate through. In comparison, DEXs involve the complexities of using crypto wallets and direct peer-to-peer transactions, which can be too technical for some users.

Enhanced security: CEXs have multiple layers of security in addition to cyber security experts who protect their virtual vaults from external attacks. Individual investors can hardly offer such levels of security. 

Cons

Hacking risk: Because CEXs are run by corporations that are accountable for the assets of their consumers, they are particularly vulnerable to cybersecurity risks.

Transaction fees: Despite the fact that cryptocurrency transactions are not taxed like equity transactions, the fees they charge are a significant financial cost.

Decentralized exchanges (DEXs)

DEXs are platforms that facilitate their users to carry out peer-to-peer transactions without the involvement of an intermediary. They only support transactions involving digital assets and do not allow the conversion of crypto to fiat currencies and vice versa. The entire exchange's funds are kept in a blockchain ledger for safekeeping.

Pros and cons of DEXs

Pros

They support anonymity: These platforms do not operate on a know-your-customer model, meaning that they do not ask for any personal identification information. This offers the privacy that comes with anonymity. 

Minimal risk of hacking: Because DEXs are not controlled by a central authority, the chances of a successful hacking attempt against them is negligible. Users can therefore rest assured that their assets are safe in DExs.   

Safer from market manipulation: As a result of the peer-to-peer nature of DEXs, crypto investors are safe from the effects of manipulative trading.

Cons

They do not support fiat: DEXs have the disadvantage of not allowing the trading of fiat currency for digital currency. Therefore, they are inconvenient for users who don't have cryptocurrency or who want to dispose of their cryptocurrency quickly.

Complex: As mentioned above, CEXs have user-friendly platforms. For their part, however, DEXs force customers to learn a more complicated process and don't offer ways to restore forgotten passwords for crypto-wallets.

Low liquidity: Only a very small percentage of people use DEXs to transact, making them extremely illiquid and prone to liquidity issues. Thus, they hinder users from transacting easily in times of emergency. In addition, users on these platforms may face higher spreads than those on CEXs.

Differences between DEX and CEX

  • Security

Decentralized exchanges are safer than centralized exchanges because they don't have as much central control. Trading on CEX exposes you to significant danger from hackers. You risk losing your entire investment if the hackers gain access to the third party that utilizes private keys to access all of the users' cash.

A DEX eliminates the threat of hacking and the resulting loss of cash. Since several users can't lose their funds as a result of a single cause, decentralized networks are safer.

  • Regulation

DExs are more difficult to control than centralized ones. Licensing is required for centralized platforms, and they must abide by the laws of the regulatory authorities in their jurisdiction.

DEXs, in contrast to centralized ones, are unregulated due to the difficulty of doing so due to the distributed nature of their blockchain. While central exchanges may be outlawed, decentralized ones can continue to operate even if their governments forbid them.

  • Liquidity

Because different users place specific orders based on market patterns, CEXs have higher liquidity. When an asset is in high demand, many people will buy and sell it at the same time. In addition, the sites have market makers that provide additional liquidity.

DEXs have comparatively lower liquidity because their transactions require order matching, which can be time-consuming.

In summary

Choosing between a decentralized and centralized exchange will be entirely dependent on your investment goals. If you're using a DEX, you'll need to take extra care to learn the functional and be ready for higher transaction costs. CEXs, on the other hand, are more efficient in offering faster transactions, but come with the denial of privacy. 

Because of decentralization, we now live in the safety bubble offered by anonymity and privacy that comes with the trustlessness of decentralization.


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