Decentralized vs Centralized Exchange – Blockchain

In this article, you will learn about Decentralized vs Centralized Exchange in blockchain. But before that, let’s see what is Crypto exchange and how to select them? Let’s start!!!

What is Exchange in Blockchain?

For anyone interested in investing or trading cryptocurrencies, the first task is to select the right crypto exchange. But what is an exchange? These are the digital marketplaces where most crypto trading takes place. You have probably heard of a few like Binance, CoinDCX, CoinSwitch, among others. Most are centralised and use a business model similar to traditional institutions like the New York Stock Exchange. But a growing number are switching to the decentralised model and radically changing how exchanges can work. Here, we explain the pros and cons of each type.

Decentralised exchanges (DEXs) have been emerging over the last five years to challenge incumbent centralised exchanges (CEXs). In simple terms, DEXs aim to offer lower transaction fees, let users directly hold their own assets and avoid some regulatory burdens. However, they face the cost of compensating their liquidity providers for a special kind of risk called impermanent loss. CEXs offer their own advantages too. They generally offer more liquidity and stronger regulatory assurances, which can be especially important for institutional clients.

What is a Decentralised Exchange?

A decentralised exchange (DEx) is a marketplace that facilitates the peer-to-peer exchange of crypto. Unlike CEXs, DEXs do not involve any intermediary. This means they appeal particularly to anyone wanting to transact without having to go through a bank. Instead, DEXs employ smart contracts which are algorithms that self-execute once certain preset conditions are met.

Because DEXs are a novel financial instrument made possible thanks to DeFi (Decentralised Finance), their infrastructure affords a bit more flexibility. For instance, while the earliest DEXs relied on order books, much like their centralised counterparts, they’ve since emerged with a variety of ways to structure themselves, which influences how they provide liquidity to users.

Since we’re still in the early developmental stages, DEXs like Uniswap feel a bit clunky and limited. Centralised exchanges like Binance may grant users a smoother user experience.

Another key difference is that CEXs can provide currencies from different blockchains. The majority of DEXs still run on the Ethereum blockchain. However, some other blockchains have released their own DEXs. They include PancakeSwap on Binance Smart Chain and Zero Exchange on the Avalanche blockchain. (Zero Exchange acts more as a bridge between chains, and can thus be considered chain-agnostic.)

What is a Centralised Exchange?

Centralised exchanges are the ones to arrive first. They made cryptocurrencies like Bitcoin, Ethereum etc. accessible to the world. These exchanges don’t offer you the personal keys of your funds to prevent any kinds of hacking and fraud. Instead, they simply credit applicable crypto numbers against your order.

Also, there’s a further need of KYC compliance and identity document submission required before using any centralised services. And this opens users to a different vulnerability of fraud or your personality data obtaining leaked via centralised exchanges.

Important Differences Between Centralised vs Decentralised Exchange

Let’s try and review some other critical differences between a CEX and a DEX.

1. Trust: CEXs act as a trusted third party to facilitate trades. They leverage their established reputation to maximise investor confidence. In contrast, with a DEX, greater ownership over your own assets requires you to learn more about how it all works. You must also carry a heightened appetite for risk. Greater knowledge affords better security and protection from malicious third parties — but it is a cost of self-custody (one that’s still very much worthwhile).

2. Security: CEXs also provide more traditional forms of security, some in the way of insurance, others in the form of regulatory compliance. Compliance usually includes KYC Verification and anti-money laundering (AML) provisions. DEXs can also provide security, but by preventing market manipulation. Thanks to blockchain technology, all transactions are recorded on the chain, so they’re traceable. A centralised exchange platform does not provide the same level of transparency, and this comes with its own risks.

3. Liquidity: CEXs tend to be able to provide a much greater amount of liquidity (and in turn, trading volume) compared to DEXs. This is partly because users can’t purchase crypto with fiat currency directly on DEXs. Hence, traders are forced to transact initially via a CEX to access their preferred fiat-crypto pairs. On DEXs, users can trade only crypto-crypto pairs.

4. Barrier to entry: People in many countries are left unbanked through no fault of their own. Because DEXs offer trading based on peer-to-peer transactions, these population groups can still trade crypto without having to be excluded simply due to the country they reside in. Also, many CEXs have become notorious for charging exorbitant fees. DEXs often charge such a negligible trading fee that it does not warrant the attention of traders.

5. Privacy: Decentralised currencies give users far more privacy protections than their centralised counterparts. The latter relies on the Know Your Customer (KYC) process. But the former allows peer-to-peer transactions to be done with near-total anonymity. This means that money can be transferred by virtually any person for any reason.

6. Usability: Centralised exchanges are way easier to use than decentralised exchanges. By entrusting transactions to a company and paying a small fee, users often get the benefits of easy access to their money. They also get tools that help visualise their assets, all of which are typically done with easy-to-use and visually appealing platforms.

7. Control: Though there are benefits to centralised exchanges, they come at the cost of control. There have been accusations of price manipulation of their currencies, and users oftentimes don’t have complete access. Withdrawal limits and market forces render it impossible for users to access their money at once, and in the worst-case scenario, the money may not be there at all.

8. Popularity: Centralised crypto exchanges are more popular than DEXs because they entered the market first. They also have more liquidity and better infrastructure to follow. However, with time more decentralised crypto exchanges are entering the market. This will definitely have a considerable impact on their popularity.

9. Features: When it comes to features, centralised cryptocurrency exchanges definitely have an edge. They provide features such as margin trading, spot trading, portfolio management tools, and many more. DEXs do not offer margin trading and also have their hands tied when it comes to types of orders.

10. Speed: Centralised crypto exchanges are faster than Decentralised crypto exchanges. The centralised crypto exchange takes an average of 10 milliseconds while DEX requires a minimum of 15 seconds to execute the order.

11. Regulations: Centralised crypto exchanges are easy to regulate as compared to decentralised exchanges.The former need licence to operate, and are compliant with the regulatory authorities. However, the DEXs are difficult to regulate due to the highly distributed blockchain. Therefore, even during a ban Decentralised exchange can operate in those regions.

12. Control: The control in the case of centralised exchanges lies with the platform. In the case of Decentralised crypto exchange, users are the ones to control the platform. This is one of the most significant reasons behind the popularity of decentralised exchanges.

13. Fees: The users of centralised crypto exchanges have to pay a certain amount of transaction fees to the exchange for using their services. DEX requires no such transaction fees.

14. Other offerings: Both popular centralised and decentralised crypto exchanges continue to come up with novel tools. These tools allow traders to squeeze even more out of the crypto assets they already own. CEXs like Binance provide trading bots to their users as well as passive-income opportunities like staking. DEXs, by comparison, provide users with options to participate in yield farming and liquidity pools.

The Decentralised Exchange: The Future of Crypto Exchanges?

There are different purposes for either exchange. If you’re purchasing crypto with fiat, it’s best to find a CEX you’re comfortable using. But if it’s small-cap coins you’re after on the Ethereum blockchain, a DEX might be your best bet.

It really does depend on your needs. The cryptocurrency market is evolving rapidly. More and more novel DeFi financial instruments are looming on the horizon.

But that won’t mean the end for CEXs — awesome DeFi innovations will no doubt bleed into centralised cryptocurrency exchanges as well.

Conclusion

DEX and CEX offer a lot more differences than the ones we have discussed above but these, however, are some of the fundamental points of differences between Decentralized vs Centralized exchange. There are different sets of benefits for using either and it all depends on the location, purpose and individual staking their money. We learnt the basics of both exchanges and discussed their future scope in the article as well.