By Nathan Ferguson
There is a boom in cryptocurrency and decentralized technologies. Despite market capitalizations skyrocketing, transaction volumes exploding, and adoption reaching a global scale, the numbers speak for themselves. Through blockchain technology, they moving towards a trustless economy in which goods can be exchanged without third parties. However, cryptocurrency exchanges today are centralized. Hackers have proven able to penetrate them, they don’t react well to an unusual event like a hard fork on the blockchain, and they’re vulnerable to government regulation.
A centralized exchange keeps its systems off-chain, which means it acts as an escrow service for clients without capturing transactions in the blockchain. Consequently, information, funds, and private keys are exposed to massive security breaches and kept in unsafe locations. In the future, many believe that trading will occur on decentralized exchanges. Decentralized exchanges are already being developed by blockchain entrepreneurs.
Through peer-to-peer market structures built directly on blockchains, most notably Ethereum, DEXs aim to eliminate problems encountered by centralized structures while preserving the control over funds of individual traders. Decentralizing and optimizing an exchange remains an impossible goal. It is easier to build centralized exchanges since they are simpler, and building fully decentralized platforms are either too expensive or technically complex – for now, at least.
A centralized exchange model has few advantages due to its drawbacks and inefficiencies. The majority of the exchanges are decentralized. The goal is to establish a market model that combines both centralized and decentralized aspects. As crypto-communities express a need, more of these exchanges are popping up.
Currently, centralized exchanges monopolize the market. There are major cryptocurrency numbers and centralized exchanges at the beginning of the “state of decentralized exchanges. This state wants to pave the way for the future of cryptocurrency trading by listing upcoming projects. They are influencing the future of cryptocurrency trading and should be considered.
Decentralized vs. Centralized Exchanges
- Control
And if you use a centralized exchange (CEX), your private keys are owned by the operator. It is common to consolidate all the funds on an exchange into a few wallets of high value. It’s easy for hackers and bad actors to steal private keys from these wallets because the business controls them. CEXs typically take extreme security measures to protect user funds, but even the best security practices cannot prevent large-scale hacks.
CEXs are custodial (meaning they hold user funds), whereas DEXs are not custodial (meaning they do not have user funds). DEX users control their private cryptocurrency keys and can move funds freely without a third party’s approval. Because hackers frequently target individuals, users must keep their private keys secure at all times. Because of this, storing confidential essential information in screenshots, documents, or emails is not a good idea. To protect sensitive data such as private keys and seed phrases, users should use hardware wallets for large amounts. Users should also keep their seed phrases and private keys in a safe place.
- Security
Across the board, centralized exchanges are difficult to assess regarding security. In comparison, some centralized exchanges have never experienced a significant security breach, while others have suffered losses worth millions of dollars. Cold wallets (offline hardware wallets) hold the vast majority of user funds on centralized exchanges, but hot wallets (online wallets) are still quite vulnerable.
Users are also still responsible for maintaining the security of their funds. The user’s responsibility is to protect their devices, for example, by using two-factor authentication, strong passwords, and allowing their addresses.
There are a lot of risks associated with decentralized exchanges, but they are safer from large-scale hacks than centralized exchanges. DEXs based on AMM may implement code that hasn’t been audited, or smart contracts may contain unknown bugs that can be exploited to drain user funds. In addition, many DEXs do not always conduct thorough security audits of the projects listed on them, making rug pulls commonplace.
Even though users control their funds, an intelligent contract is locked into DEXs, adds centralization, and thus creates security risks for DEXs. DEXs based on order books are more secure since they do not require “locking” funds in smart contracts.
Check out our guide on decentralized finance for more information on other blockchain-based applications. Some decentralized exchanges, such as Trezor (pictured above) and Ledger, support trading via hardware wallets that make them more secure than centralized exchanges.
- Popularity
CEXs used to be the only choice for cryptocurrency traders only a few years ago. Trading volumes on DEXs were shallow, and they were very complicated. The popularity of centralized exchanges hasn’t changed much since then despite many improvements in DEX usability. It is mainly due to a few factors. The first is the lower trading fees offered by many CEXs. CEXs, for instance, do not charge gas fees (on-chain transaction fees) when a user wants to trade ETH for DAI or vice versa. Additionally, CEXs facilitate the trade of assets between different blockchain networks.
Market makers (liquidity providers) are rewarded with incentives and have access to a more significant number of trading partners, which has led to a boom in users. In the aftermath of Ethereum becoming overly crowded, Uniswap and other ERC-20 DEXs became unusable for small trades, binance innovative chains based DEXs (e.g., PancakeSwap) gained popularity. As the technology behind DEXs becomes more powerful, they become more mainstream.
How does a centralized cryptocurrency exchange work?
A centralized cryptocurrency exchange allows you to buy and sell digital assets. The buyer and seller must entrust a third party to monitor the deal and secure the assets in this case. The blockchain does not track these deals. Personal information must be provided during such exchanges. The exchange, however, would need your corporate information to verify your account if you were a company.
In exchange for more information, you will be able to withdraw more funds. In the case of a technical error or if they forget their password, verified users of these platforms can contact the exchange’s support team.
The prices on flat pairs provided by centralized crypto exchanges are often stable. It is easy to locate one of these exchange platforms online, and they are very popular among cryptocurrency users. Among the centralized cryptocurrency exchanges, there are Binance, Coinbase, and LocalBitcoins.
A central exchange’s key components
The number of centralized cryptocurrency exchanges is constantly growing. However, some of these exchanges will not succeed, and many of them will fold. Exchanges can succeed or fail for a variety of reasons. Trade volume is the most important factor.
The higher the trading volume on an exchange, the less likely it will suffer from market manipulation and volatility. You should also consider market volatility. Because transactions take time to complete, the price of a transaction may change between when it is initiated and when it is completed. As trade volume increases and transactions can be processed faster, this fluctuation will be less likely to be a problem.
A centralized exchange’s success is also dependent on security. There are some exchanges that are safer than others, despite the fact that no exchange is completely secure. Exchanges have no control over how they react to events such as hacks. Other exchanges have not been as successful in refunding customer losses. Other businesses have closed because of this type of attack. Centralized exchanges are typically the place where investors enter the cryptocurrency space.
Consider a variety of factors before choosing an exchange, including the pairs traded, the trading volume, and the security measures taken by the exchange to protect customers.
Describe the concept of a decentralized exchange of cryptocurrencies.
The difference between a DEX and a centralized exchange is that the DEX is decentralized. Every transaction is recorded on the blockchain.
Exchange platforms that allow peer-to-peer trading use assets, proxy tokens, or escrow accounts to help facilitate peer-to-peer trade, as opposed to centralized exchanges whose systems are based on IOUs.
Decentralized cryptocurrency exchange: how does it work?
When you use a DEx, you (the client) bring your cryptocurrency to the gate, which stores it and then gives you proxy tokens in the position of your cryptocurrency. You can now access the blockchain using these tokens. These tokens have been collateralized with real cryptocurrency.
In exchange for your current tokens, you can exchange them for another. In these places, all aspects of your order, including the process of matching it, as well as all subsequent processes, are stored on the exchange’s blockchain. Tokens received through transactions can also be converted into real cryptocurrency.
The popularity of bitcoin and ethereum has led to an increase in people exploring crypto. Using large exchanges like Binance or Coinbase can be done easily. Nevertheless, they come across exchanges like Uniswap as they explore the world.
In researching Uniswap and the like, they discover some say they are more aligned with crypto ideals. They are more user-friendly, say others, and Coinbase has more tradable products. So Uniswap is a decentralized exchange, but centralized exchanges like Coinbase are centralized. What makes Uniswap different? The issue of centralized (CEX) and decentralized (DEX) exchanges will be clarified by explaining the fundamental differences.
Centralized Vs. Decentralized Cryptocurrency Exchange: A Comparison
Let us now explore the differences between centralized and decentralized exchanges, comparing features, security, crypto-asset diversity, liquidity, fees, and authority to understand the difference.
Features
Compared to decentralized exchanges, centralized crypto exchanges offer better functionality. You can increase your trading performance by using a variety of order types and margin trading tools.
However, decentralized crypto exchanges don’t offer margin trading (or other similar services) to their customers or even allow them to place orders. Decentralized systems will offer more functionalities as they become more advanced.
- Security
The crooks steal millions of dollars of cryptocurrency from people who purchase unknown currencies and lose their entire investment. Your wallet is also held in your centralized exchange, similar to the centralized exchange. It is possible to reset the exchange if you forget the password. The decentralized exchange cannot reimburse you if it tricked you. Unless you remember your seed phrase (a set of random characters you receive when you create your wallet), you’ll not be able to change your password.
Therefore, it is unlikely that you will exchange potatoes for milk and then realize your mistake at home. The centralized exchange is also the one that holds your wallet or personal safe. You can request your wallet’s password be reset if you forget it. A fix cannot be found if you are in the DEX world. The wallet belongs to you, so you cannot reset the password if you forget your password or seed phrase (a string of random characters you know).
Suppose. However, the police visit your village one day and declare the centralized market exchange illegal. It could also be robbers (hackers) breaking into the market. You know those things you have to keep in your safe at the market exchange? All of them have disappeared. In contrast, even if a DEX shuts down, your neighbor who has traded there keeps all of his assets.
- Liquidity
Liquidity levels on decentralized exchanges have fallen far below those on centralized exchanges, one of the biggest disadvantages. To resolve this issue, some DEXs recently implemented Automated Market Makers (AMMs). In spite of its considerable value proposition, AMM cannot replace centralized order books with centralized liquidity.
- Fees
Traders of cryptocurrencies are generally concerned about trading fees. The white-label DEXs work the same way as CEXs, charging a percentage of each transaction cost, whereas centralized exchanges charge a flat fee per trade! A decentralized exchange must therefore charge a fee for confirming trades via blockchain once the transaction is ready to be published. Each chain charges a different fee.
- Authorized
In addition, DEX bitcoin offers users the convenience of keeping their assets under their control. CEXs retain all currency possession. The user does not need to provide access if the key exchange is delayed. This may result in a quicker execution. Nevertheless, it might be a security risk! Here’s an example from real life. Coincheck Exchange’s hack contributed most of the $713 million stolen in 2018.
- Crypto Asset Diversity
In 2021, there will be over 4,000 different cryptocurrencies. For an asset to appear on a CEX, it must meet certain security requirements, be traded, and follow legal requirements. Any item can be listed in a DEX. Risk increases, but you also have a chance of trading highly-demanded new assets. The price of that mango might increase soon, even though everyone has milk and potatoes. Don’t let your money and assets become rotten by not doing your research.
FAQs – Centralized vs. Decentralized Exchange
- How is cryptocurrency decentralized?
Unlike centralized exchanges, decentralized exchanges aren’t controlled by a single entity. Decentralized apps and smart contracts replace traditional centralized exchanges for automating trades and transactions. By running their important activities on the blockchain, decentralized crypto exchanges allow users to retain control of their assets compared to centralized crypto exchanges.
- How do decentralized exchanges work?
To swap one asset for another is placed by a token owner on the decentralized exchange, a non-centralized alternative to centralized exchanges. Along with determining how many tokens they must sell, how much they must charge, and how long they must accept bids, the token owner decides these factors, too. Bids can then be placed by other users after the selling order has been made. All offers are evaluated and executed after the sellers choose the time.
- Why are decentralized exchanges better than centralized ones?
In contrast to DEX, which anyone party cannot hack, a centralized exchange is more susceptible to attacks, leading to huge losses for users. Furthermore, users retain control over their cryptocurrency holdings because they have access to their wallets.
- How does a Decentralized Cryptocurrency Exchange work?
When you use a DEx, you (the client) bring your cryptocurrency to the gate, which stores it and then gives you proxy tokens in the position of your cryptocurrency. You can now access the blockchain using these tokens. These tokens have been collateralized with real cryptocurrency.
In exchange for your current tokens, you can exchange them for another. In these places, all aspects of your order, including the process of matching it, as well as all subsequent processes, are stored on the exchange’s blockchain. Tokens received through transactions can also be converted into real cryptocurrency.
Bottom Line
Even though a centralized exchange is easier for users to use and theoretically safer, decentralized exchanges may eventually replace centralized exchanges as the industry standard. You are more concerned about making money today than what will happen ten years from now if you trade bitcoins and other crypto assets. Generally speaking, CEXs are one of the safer methods to begin trading cryptocurrencies, while DEXs can potentially offer greater rewards if you play the game right.
In the end, both must be done. You should not invest anything that you can’t afford to lose when investing in cryptocurrencies. Instead of the potatoes you worked so hard to grow, you will end up with a sack of spoiled milk and rotten cryptos.