Centralized exchanges are very popular among people who want to sell or trade cryptos. They enable traders to use a secure interface to perform their trades. But in the emerging world of decentralized finance and self custody more and more crypto holders and enthusiasts are pondering, ‘what are the major downsides of centralized exchanges?’.
And that is what I will be discussing in this post; that is, what is the definition of a centralized vs decentralized exchanges in crypto, what are the advantages of each and what are the major downsides of centralized exchanges vs decentralized exchanges?
And if you are interested in trading crypto (stocks Forex or any other asset) then it’s vital to have a very good understanding of the fundamentals of day trading and market movements in order to become a profitable trader.
And understanding the pros and cons of centralized vs decentralized exchanges will definitely help in your day trading crypto knowledge.
Centralized exchanges have their pros and cons. So, before using one or choosing a centralized exchange instead of a decentralized one, you should know the advantages and disadvantages. Keep on reading to find out what to expect.
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Table of Contents
What is a Centralized Exchange in Crypto?
Centralized Exchanges in cryptocurrency are also known as a CEX and in basic terms they are platforms that facilitate cryptocurrency trading i.e the buying and selling of crypto assets.
Crypto trading on a centralized exchange is mostly large scale and CEX’s use traditional financial models similar to stock exchanges like the New York Stock Exchange.
A major defining feature of a centralized exchange is the existence of a central authority that facilitates trades, mostly on a large scale using traditional financial models of business.
Centralized exchanges match up many, many buyers and sellers in order to facilitate trades and they do this using a digital order book. When it comes to crypto, the most popular centralized exchanges include Binance, Coinbase, Crypto.com, Gemini and Kraken.
In a centralized exchange, the company that owns it will have total control over the transactions. CCE users don’t have access to their exchange account wallet private keys. Therefore, the exchange operators are the ones in control of everything, and users have to trust them with their funds.
But centralized exchanges have a physical location, and they are regulated, meaning that users will be able to sue the company when something bad happens. They can also hire lawyers for centralized exchanges to help them with the case.
Related Read: Day Trading Side Hustle – Doing It Successfully
What is a Crypto Decentralized Exchange?
A Decentralized Exchange (DEX) is a platform where buyers and sellers exchange their crypto assets without a middle man. There is no central authority in a DEX. Instead exchanges take place using smart contracts.
Smart contracts are basically code on a blockchain network that execute an action (such as an exchange of assets) as long as the conditions are met. Exchanges can take place peer-to-peer through the DEX.
A major defining feature of a decentralized exchange is there is no central governing authority to facilitate trading of assets. By making use of a widely distributed network of users that are connected by the blockchain, DEXs operate without a central authority.
Well recognized decentralized exchanges in the crypto today include Uniswap, Sushiswap and Pancakeswap.
Centralized vs Decentralized Exchange – Popularity
When it come to popularity and total number of daily users, centralized exchanges are more common and more utilized than decentralized exchanges.
A lot more popular.
A KPMG report found that 95% of crypto exchanges take place on centralized exchanges. In fact the largest centralized exchange for crypto in the world today processes $20 billion worth of exchanges daily.
In comparison the largest decentralized exchange, Uniswap, processes $2 billion worth of transactions daily.
Pros of Centralized Exchanges
Centralized cryptocurrency exchanges are private companies offering crypto trading. Thanks to them, investors are able to buy cryptocurrency with fiat currency and sell it. Of course, they also have the chance to exchange a cryptocurrency for another.
Trading can occur smoothly, on a platform with an organized interface. The companies hosting the exchanges are licensed and have their own employees. But this is only the surface: centralized crypto exchanges have many benefits.
Fast Transactions
Speed is one of the main reasons why centralized exchanges are so popular among investors. The quick transactions will allow complex trade types to take place but will also improve the experience of the users.
They Offer Protection Against Scandals
Cryptocurrencies are used with Internet access. A lot of complicated jargon is usually associated with centralized exchanges. This is what makes a lot of beginner investors quite afraid to start their crypto trading experience.
Without a centralized agency, the transactions can be quite risky. Many scandals had to be endured by crypto investors, so conservative investors want to make sure that they work with a reputable company to protect them from such scandals. Therefore, centralized exchanges are the saviors in this situation because they are regulated by the government and have a physical location.
Easier to Use
It is much easier to use a centralized exchange, especially as a new investor. This is because the transactions are entrusted to a company. Even though they need to pay a small fee for this sometimes, people can get tools to monitor their assets and gain easy access to their money.
Safety Insurance
Just like any other crypto exchange, centralized exchanges are also susceptible to digital attacks. Hackers may target them at any point, looking to put their hands on the crypto assets. But centralized exchanges are insured for a small extra fee. This way, investors can rest assured that they will be protected in case a digital attack happens.
Trading crypto can be very profitable whether using a centralized or decentralized exchange. But the best way is often to simplify trading technical analysis and indicators in order to become a consistent and profitable trader.
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What are the major downsides of centralized exchanges?
As you can imagine, centralized exchanges also have their fair share of downsides. And some of these downsides or risks have really come to light after the recent FTX collapse and scandal which have cost FTX users access and control of their funds in the order of millions worth of crypto assets.
Less Privacy than Decentralized Exchanges
Decentralized exchanges offer more privacy for their users. With centralized exchanges, customers have to go through the Know Your Customer process.
Decentralized exchanges use peer-to-peer transactions, which can be done anonymously. Therefore, you can send money to anyone for any reason, something that is not possible with centralized exchanges.
Bankruptcy Risk
Centralized exchanges are private businesses, so the money they have in custody is a loan they got from an investor. The change of default is always there with a loan. So, anyone who uses a centralized crypto exchange will be at risk of losing money due to this matter.
Less Variety
A lot of centralized exchanges are focusing more on safety than variety. For this reason, they will have fewer cryptocurrency types available for trading. Usually, no more than 40 or 50 can be found on these exchanges. Sure, it may not be an issue if you are using one of the most popular cryptos like Bitcoin or Ethereum, but it still limits trading options for many people.
Security Risks
Centralized exchanges are susceptible to hacking and security breaches. High-profile incidents in the past, such as the Mt. Gox hack, have resulted in significant losses for users. Centralized exchanges hold custody of users’ funds, making them attractive targets for hackers.
Lack of Control
Users entrust their funds to the centralized exchange, relinquishing control over their assets. This centralized control contradicts the ethos of decentralization that underpins cryptocurrencies.
Centralized exchanges like FTX often lack transparency, leaving users in the dark about how trades are executed or how funds are managed behind the scenes.
Regulatory Vulnerability
Centralized exchanges are subject to government regulations and may face compliance issues, leading to disruptions in service or even closure. This regulatory uncertainty can negatively impact users’ ability to trade and access their funds.
Lack of Transparency
Transparency can be lacking in centralized exchanges, leading to concerns about market manipulation, insider trading, and lack of accountability. Users may not have full visibility into how trades are executed or how funds are managed.
Central Point of Failure
Centralized exchanges represent a single point of failure in the cryptocurrency ecosystem. If a centralized exchange experiences downtime or operational issues, users may be unable to access their funds or execute trades, leading to potential financial losses.
Conclusion
When it comes to investing in and trading crypto, centralized exchanges are by far the more regulalrly used and popular choice. This is due to various reasons discussed in this post including ease of use and access as well as safety insurance and customer support which are not really avilable on decentralized exchanges.
But they have some downsides as well to centralized exchanges which have also been discussed above such as having less variety, less privacy, and being at risk of bankruptcy.
It is up to you to analyze the pros and cons and decide if you want to go with a centralized exchange or to trade and invest more using a decentralized exchange.
My opinion is that both offer value and it is always best to broaden knowledge so why not learn to use both and diversify your poftfolio and reduce risk by spreading out your crypto assets cross both types of exchanges.
