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Crypto exchanges like Coinbase, Binance and other major crypto-based companies have led cryptocurrencies into mainstream consciousness over the past decade. These centralised exchanges are also the most common way people buy their first digital assets. However, decentralized trading platforms like Uniswap have emerged as a more transparent and accessible alternative to trading crypto.
In this article, you’ll learn:
In this way, you’ll be able to better understand which type of exchange suits your trading needs and preferences so you can decide if it’s better for you to trade crypto at a CEX or a DEX.
A centralized crypto exchange is a platform that helps people to buy, sell or swap digital assets using fiat currencies and other cryptocurrencies. Simply put, it’s where you go to have someone help you exchange one type of currency – fiat money or cryptocurrency – for another.
The term centralised itself is seldom actually used to describe a CEX – it simply refers to the fact that the exchange is operated and managed by a company. This company or exchange handles all of your transactions on your behalf, and even stores any funds you deposit with them in their own wallets. You access a CEX through your own account and are assigned crypto wallets opened under the exchange’s management.
This is where the term custodial is also sometimes used to describe centralised exchanges, since they are the trusted intermediary that acts as asset custodians, by storing and protecting customer funds.
Since CEXs first emerged around 2010, they continue to be the most widely-used method to buy and trade cryptocurrency. In most countries, CEXs work closely with regulators to ensure they meet minimum industry standard for security, tax requirements and financial legislation. It is quite common, therefore, for a centralised exchange to obtain various banking, trading and financial institution licenses and permits to allow them to operate in their respective jurisdictions.
Read this Learn Crypto article to go in-depth into what are decentralised exchanges, their evolution and why they’re a big deal.
In the very early days, getting your hands on cryptocurrency wasn’t as simple or easy to do for regular people since using crypto wallets required a certain level of technical knowledge and computer skills. Most people also had to buy crypto informally or from other people using peer-to-peer methods.
Centralised crypto exchanges led the charge in crypto adoption, making it easier for non-technical users to access and buy or sell cryptocurrency using money from their bank accounts or credit cards. It has to be said that CEXs played an important role in developing public and institutional trust in cryptocurrency as well as their underlying blockchain technologies.
In recent years, payment giants like PayPal have also entered the space, bringing crypto exposure to tens of thousands of existing users.
However, as the blockchain and crypto industry matures, there has been in recent years a push toward building a service infrastructure that better reflects the original ethos of decentralisation.
A major part of this push has been reactionary to significant security events since 2013 involving centralised exchanges like Mt Gox, KuCoin and others. Losses of millions of dollars in stolen, hacked or mismanaged cryptocurrencies, also brought to light the heightened risk of funds when stored on centralised exchanges. In essence, when centralised exchanges are badly managed, then they are either negligent with their security or do not practise enough transparency, allowing them to make bad financial decisions that lead to insolvency.
The term decentralised suggests a greater degree of transparency and accessibility – instead of a company acting as an intermediary, decentralised exchanges or DEXs run on a computer protocol that automatically handles crypto trade transactions, executing trades and swaps according to conditions set by code.
Another key feature of DEXs is that user funds are also not stored on the exchange. Instead, funds still remain under the control of the user on their own crypto wallets.
This is why DEXs are also sometimes called non-custodial exchanges.
In reality, non-custodial is also probably the most technically accurate way to label DEXs since their greatest and most important difference lies in who controls the user funds. CEXs control user funds and DEXs don’t.
Other aspects aren’t necessarily completely decentralised. For example, there are still companies or groups that manage DEXs on their own servers and they are the same people who write the code that operates the DEX. Some DEXs even censor certain users, or are able to unilaterally take over some protocols to fix certain things – just as a CEX would do.
In this way, decentralised exchanges do vary in the lengths they take to decentralise every aspect of crypto exchange.
Nevertheless, modern decentralised exchanges have grown in popularity and are the driving force behind an emerging suite of decentralised finance (DEFI) solutions that allow people to access financial services and products without intermediaries.
As explained, there are several differences between how centralised crypto exchanges and decentralised crypto exchanges operate. The fundamental difference is that centralised exchanges control user funds while decentralilsed exchanges allow their users to maintain control of their funds.
Choosing the right type of exchange to trade crypto, however, does depend on more than just custody of crypto. Different users have different requirements and may be surprised to find that their needs may match them in unexpected ways.
This article now examines the advantages and disadvantages of both the CEX and the DEX.
Centralised exchanges are generally huge commercial entities and start their platforms with a lot of investors and backers. This allows them to handle large volumes of trading and offer high liquidity – which simply means that it is very likely to accept and transact any amount of trade from any user very quickly.
This is generally why large corporate or institutional trades are normally handled by brokers who spread customer orders across several large centralised exchanges. This also means that regular users can expect their assets to be traded easily and instantly.
Binance, for example, recorded over $76 billion every day in 2021 (BusinessofApps).
Centralized exchanges generally allow the use of both fiat money and cryptocurrency on the same platform. Users can deposit both types of currency and withdraw with either option as well.
Additionally, centralised exchanges tend to have what they refer to as fiat on- and off-ramps. A fiat on-ramp allows users to directly purchase cryptocurrency with fiat currencies like US dollars via card, bank or other money transfer methods like Western Union or PayPal. A fiat off-ramp allows users to convert their cryptocurrency using the same methods into fiat currency.
Centralised exchanges invest a lot of effort to building their user interfaces so generally do a good job of funneling newcomers into the crypto space. Dashboards are smoother and more intuitive.
More advanced users or traders are usually also able to access more sophisticated trading tools resembling online stock or forex brokers, to produce trading charts and other analytics, or to connect automated trading bots to manage their trading.
In this sense, CEXs can appear familiar to traditional traders who use online brokers.
As centralised exchanges are generally under the control of regulators, they must comply with all the legal regulations in their particular jurisdiction. This can mean they do collect extensive data on their customers and even impose restrictions on certain users. On the other hand, this also makes it clearer to the user as to whether or not it is legal to use in their country.
It may also help certain users in some countries perform their tax obligations on crypto trading and holdings, as CEXs are required in some countries to provide the right tax data to their customers.
This may also offer some form of user protection should things go wrong – for instance, Coinbase keeps some US customer funds on Federal Deposit Insurance Corporation (FDIC)-insured banks in the US, so these deposits are protected by that insurance.
As most centralised exchanges must comply with the different regulatory requirements of their jurisdictions, they must subject their users to strick KYC and Anti-Money Laundering (AML) procedures.
This can be as simple as identifying your phone number and email address but often, for higher limits, you will need to provide photographic evidence of your identity, video identification, and even proof of source of funds (bank statements, declarations, etc.) and proof of income (salary slip, employment letter, etc.).
There usually is no way to know if your data is protected securely on their servers, and even with General Data Protection Regulation (GDPR) rules, you may request the withdrawal of your personal data but give up your access.
All CEX wallets are custodial, meaning to say they are ones who hold the authority over your assets. You will see your balance in your account and even have a personal crypto address to deposit funds into, but these still belong to the centralised exchange. You will never be given the private keys – the sole control to a crypto wallet.
If they were to lose access to these wallets, or get hacked, then your funds are gone.
The warning phrase “Not your keys, not your coins” is a reminder to crypto users not to store funds at exchanges. Read more about crypto custody in this Learn Crypto article: “What is Crypto Custody”.
Since centralised crypto exchanges hold a lot of user funds and personal data, they happen to be a favourite target for online hackers and crypto thieves.
As they store their data on centralised servers or rely on employees to conduct strict security practices, human error and negligence can and often has led to exchange hacks. Over the years, billions of dollars of user funds have been lost in this way.
Centralised exchanges are large companies with hundreds of employees handling accounts, customer support, marketing, security, engineering, and a host of other user services and products. Their overheads on salaries alone is substantial, not to mention rental, server costs, and computer security.
These costs are often passed on to customers, reflected either in high transaction fees or commissions.
Anonymity in the financial space is a great motivator to use a decentralised exchange. The vast majority of DEXs require no authentication procedure, no identification or Know Your Customer (KYC) processes, and do not ask for users’ personal documents.
All that is needed in most cases is simply the personal address on a crypto wallet on the blockchain and users can trade with a DEX. Users are also free to use other privacy services like VPNs to protect their internet identities like device ID and IP address.
As discussed, the key advantage of a decentralised exchange is that they are non-custodial. This means that they never need to view the private keys protecting user funds on their crypto wallets.
Bear in mind that this doesn’t necessarily protect your crypto assets completely. Improper access to malicious DEXs or fake protocols, or using a device compromised by a phishing attack likely puts you at the same hacking risk as using a CEX.
While the larger and most popular DEXs to employ many employees, some DEXs still manage to operate with a handful of staff, keeping operating costs low. With little or no physical office rental to pay, or customer support to handle client cases, costs are lower.
In fact, the very best DEXs levy a small commission on trading, and most of that goes back anyway to the users since users are the ones providing assets and liquidity at DEXs.
DEXs also don’t charge transaction fees. Instead, users themselves pay miner fees directly to the blockchain networks, and these tend to be far lower than the fixed fees charged by CEXs.
Unlike the powerful and feature-rich dashboards of centralised exchanges, decentralised ones tend to be far more limited in functionality and even ease of use.
You may not find advanced trading options like margin trading or limit orders at many DEXS, or even advanced charting tools that professional traders require.
Early DEXs that ran on order books failed as they were unable to attract high liquidity to compete with CEXs (read more about the history of DEXS in this Learn Crypto article).
Nowadays, modern DEXs are capable of higher liquidity yet most still struggle to maintain a level that would attract institutional traders. This means that larger trades may not execute properly – you might either not find enough to fit your order, or you are forced to accept an offer with a poorer rate than you asked for.
The biggest DEXs like Uniswap or Pancakeswap are pretty fast, with trades happening in a matter of seconds. But at peak times or during network congestions, it’s not uncommon to see them slow down. This is a matter of blockchain scalability, which has to do with the transactional capacity of most blockchains.
CEXs don’t face this issue as they run on fast centralised servers that can execute millions of transactions each second.
This may not be crucial to normal traders, but for professionals who require instant reactions to fast-changing market situations, DEXs speed of settlement render them highly unsuitable.
Decentralized exchanges run on protocols that are defined by computer codes – you might see the term smart contract quite a lot.
While many have been vetted and audited to prevent security loopholes or vulnerabilities that can be exploited, most users and developers will only find out about dangerous vulnerabilities after a hacker has.
Unfortunately, this is precisely what happened in the early days of DEFI, where many hackers exploited DEXs to steal user funds. Additionally, malicious developers continue to hide bad code in their smart contracts, waiting for the right moment to activate and steal funds.
Both types of crypto exchanges play a major role today in giving newcomers their first exposure to cryptocurrency but have some differences in how they manage crypto storage, liquidity, platform and data security, as well as usability.
If you are a reasonably experienced crypto owner, and privacy and control over your funds are of the utmost priority, and you are willing to understand more about how to use cryptocurrency in a more decentralised manner, then a DEX should meet your needs – though it is perhaps advisable to stick to larger, more established DEXs.
If you are an absolute beginner, then the intuitiveness and fiat on/off-ramps of CEXs might be the better way for you to start. Additionally, if you’re looking for powerful trading tools and prefer legal clarity to do your taxes, for example, a licensed CEX in your country is likely the better option.
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