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Centralized and Decentralized Cryptocurrency Exchanges

  • Kanan Arora
  • Aug 06, 2021
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Introduction 

 

Cryptocurrency exchanges are platforms that facilitate the trading of cryptocurrencies for other assets, including digital and fiat currencies. Just like stock exchanges facilitate the trade of stocks, crypto exchanges facilitate the trade of cryptocurrencies.

 

The world’s first stock exchange is the Amsterdam Stock Exchange in the Netherlands, founded in the early 60’s. Since then, almost all countries worldwide have established their own stock exchanges and most are traded with decent liquidity daily.

 

Most of the people today are familiar with the concept of stocks and are comfortable participating in stock exchanges due to the mature nature of the same today. Catch in detail regarding the largest stock exchanges in the world.

 

Cryptocurrency exchanges on the other hand are a relatively newer concept since cryptocurrencies are relatively younger assets. The history of cryptocurrency exchanges dates back to 2010 when Bitcoin developer Gavin Anderson created a bitcoin “faucet”, a website to distribute free bitcoin. Eventually Bitcoin Market was launched in the same year followed by the emergence of the then notable exchange Mt. Gox. 

 

Cryptocurrencies have recently become asset classes attractive to a lot of the investors that have been fascinated by the splendid returns provided by the same. With cryptocurrency occupying some portion of investor portfolios, crypto exchanges are becoming more and more active in terms of investor and trader participation as gauged by the volumes being traded on them.

 

This blog explores the two types of crypto exchanges used : centralized and decentralized exchanges and compares the relative pros and cons of using these exchanges for the purpose of investing in and trading cryptocurrencies. Towards the end, the blog lists 4 of the top crypto exchanges being used worldwide.

 

(Also read: Benefits of stock exchanges)

 

 

Centralized Cryptocurrency Exchanges

 

As suggested by the name, centralized cryptocurrency exchanges act as a third-party between a buyer and a seller. Approximately all of the crypto transactions go through centralized exchanges since they offer more reliability. Coinbase, GDAX, Kraken and Gemini are some of the examples of centralized cryptocurrency exchanges.

 

Advantages

 

  • User-friendly: Unlike using crypto wallets and doing peer-to-peer transactions, which can be complex and cumbersome, centralized cryptocurrency exchanges provide friendly user interface and easy to use platforms including website and apps which make it comfortable to transact in cryptocurrencies at any point of time. 

 

Just like applications like Robinhood provide a platform to trade stocks in a friendly manner, most of the centralized cryptocurrency exchanges have similar platforms.

 

  • Reliable: When talking about cryptocurrencies, reliability is a significant concern for investors and traders who are already participating in a relatively more uncertain environment than the traditional bonds and stocks. This is where centralized crypto exchanges provide an edge by providing an extra layer of security and reliability when it comes to transactions and trading.

 

They do so by facilitating the transaction through developed and centralized platforms, just like most of the stock exchanges worldwide do.

 

(Most recommended: What is digital money?)

 

Disadvantages

 

  • Hacking Risk: Since centralized exchanges are operated by companies that are responsible for the holdings of their customers, they are highly susceptible to hacking risk or cybersecurity risk. 

 

Mt. Gox, which was one of the biggest and most trusted centralized crypto exchanges, suffered a massive hack in 2014. The hack resulted in 850,000 bitcoins amounting to more than $460 million in customer funds being stolen. Mt. Gox declared bankruptcy after the hack 

 

  • Transaction Fees: Centralized crypto exchanges charge a decent amount of fees for the services they provide. Even though, unlike equity, taxation is not applicable while transacting in cryptocurrencies, the charges imposed by centralized exchanges form an important financial cost. As an example, Binance charges a transaction fee of 0.012% to 0.1%.

 

(Related blog: Most stable cryptocurrencies)

 

 

Decentralized Cryptocurrency Exchanges: 

 

Decentralized cryptocurrency exchanges allow users to execute peer-to-peer transactions without the need for a third party. However, decentralized exchanges do not facilitate the trading of fiat currencies for cryptocurrencies. 

 

Uniswap (V2), Tokenlon, 0x Protocol and Venus are some of the examples of decentralized cryptocurrency exchanges. 

       

Advantages:

 

  • Anonymity: Unlike centralized cryptocurrency exchanges which require customers to fill out certain details including KYC or know-your-customer details while opening an account, decentralized exchanges are anonymous and offer complete privacy.

  • No hacking risk: Decentralized exchanges form a good alternative for investors concerned over hacking risk since the users of decentralized exchanges do not need to transfer their assets to a third party that may get hacked. 

  • Preventing Market Manipulation: Since the interaction is peer-to-peer in decentralized exchanges, crypto participants are protected from market manipulation. 

 

(Suggested reading: Top 10 Companies Adopting Bitcoins)

 

Disadvantages:

 

  • Lack of fiat payments: Perhaps the biggest disadvantage of decentralized exchanges is that they do not allow the trading of fiat currencies for digital ones. The users who do not already hold cryptocurrencies or who wish to have the opportunity to liquidate their cryptocurrencies as per ease will find it inconvenient to transact using decentralized exchanges. 

  • Complexity: Since centralized exchanges provide their own platforms to transact, they provide user friendly features. On the other hand, decentralized exchanges demand the users to get familiar with a relatively more complex process and do not provide methods to recover password(s) provided the password(s) to crypto wallets are lost.

  • Liquidity: A very few people (just about 1%) transact using decentralized exchanges, so decentralized exchanges are highly illiquid and may provide liquidity constraints at times. This leaves a user unable to transact seamlessly in emergency situations and may result in higher spreads as compared to transacting in centralized exchanges. 

 

(Recommended read: Dogecoin vs Bitcoin)

 

 

Top 4 cryptocurrency exchanges

 

  1. Binance: 

 

Binance is the biggest cryptocurrency exchange based on the average daily volumes being traded. It provides hundreds of currencies for trading and charges relatively lower fees than other commonly used exchanges. It also provides advanced charting systems without the user having to upgrade.

 

  1. Coinbase: 

 

Coinbase has largely avoided any crypto fraud so far and provides an extremely strong platform for trading. It also offers a Pro version with significant lower transaction costs and significantly more technical features. Coinbase allows the transactions in 64 crypto currencies. 

 

  1. Cash App: 

 

Cash App forms the best cryptocurrency exchange for beginners since it provides an extremely simple user interface and a myriad of other fundamental features including the opportunity to invest in equity. Cash App, however, only allows the user to trade in bitcoin and no other altcoin. 

 

  1. Bisq

 

Bisq can be regarded as the best decentralized crypto exchange. It provides a completely anonymous, non-KYC platform with more than 25 different payment options. It follows the decentralized principle of cryptocurrencies but presents liquidity and speed-related challenges. 

 

(Read also: Fundamental analysis guide)

 

 

Conclusion

 

Cryptocurrencies are still immature when compared to other asset classes including equity, commodities, bonds, currencies, etc. This immaturity arising due to cryptocurrencies being newer asset classes results in cryptocurrencies being extremely volatile.

 

However, the financial market’s participation fueled by the high levels of liquidity and the anticipated revolutionary potential of cryptocurrencies have increased substantially in the past few years. 

 

Cryptocurrencies still belong to a largely unexplored territory and a lot of the people, even those who participate actively in cryptocurrencies do not have a sound knowledge of the fundamentals of the same.

 

(Must read: Technical analysis)

 

With time, the popularity and the knowledge surrounding bitcoins is anticipated to increase and with this, the volatility is anticipated to decrease over time. In the process of the maturing of cryptocurrencies, crypto exchanges are playing a massive role as can be seen by the spike in the volumes of cryptocurrencies being traded on the various exchanges in the recent past.

 

This blog discussed the two types of crypto exchanges namely centralized and decentralized. Centralized exchanges form a majority of the transactions taking place in cryptocurrencies and are seeing a strong increase in both institutional and retail participation worldwide.

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