The difference between a centralized and decentralized exchange

A crypto exchange is an online platform where everyone can buy, sell, or trade crypto. It functions the same way as stock exchanges, providing customers with all tools needed for investing in digital assets. However, how exactly your transaction will be executed depends on the exchange you choose. There are two distinctive types of crypto exchanges – centralized (CEX) and decentralized (DEX). Both have their pros and cons, so if you’re looking to find out which one will be best for your crypto needs, you came to the right place!

What is a centralized crypto exchange?

In the world of cryptocurrencies, which by definition are decentralized, the concept of centralized exchanges may be a bit misleading. But don’t let it confuse you – centralization in this context simply means there’s a third party that facilitates transactions between two users. You probably heard about Binance, Coinbase, Kraken, Gemini, and FTX. All of them are centralized exchanges, where the platform acts as a middleman between buyers and sellers. The platform founders also own the exchange, which means that at any moment, they can halt all operations, ban certain users from transacting, and more.

One of the key features of CEXs is that they’re custodial. It means that the exchange keeps your private keys to the wallet. If you forget your password, you can always ask the exchange to reset it. On the other hand, losing the key on DEX equals never seeing your coins again. However, there’s another side of the medal – hackers may breach the security of CEX and steal everything you have in your wallet.

Another perk of using a centralized exchange is its intuitively understandable interface. The barrier to entry is low, and most people set their first step in the world of crypto on CEXs. Plus, due to their popularity, centralized exchanges usually don’t have problems with liquidity.

You’re also less likely to come across a scam on CEX. Of course, the probability doesn’t equal zero, but it would definitely make the news if it were to happen. All the coins listed on CEXs have to meet specific criteria, like having a number of active blockchain addresses, an active audience on social media, and code commits. However, it also means that if you want to buy an exotic coin only a few people have heard of, you’d have to go on DEX.

Finally, all CEXs must comply with regulators’ requirements, so every new customer must go through a KYC procedure that includes confirming your ID and residence.

To sum up, choose CEX, if:

  • you’re a beginner in crypto
  • you want to buy crypto for fiat
  • you’re OK with revealing your identity
  • you’re fine with the lack of complete ownership of your account

What is a decentralized crypto exchange?

Modern DEXs use an automated market maker algorithm that removes the intermediary between two transacting parties. Unlike CEXs that rely on institutional investors and traders to provide liquidity, DEXs allow any user to supply crypto to the liquidity pools that replace trading pairs on traditional exchanges. If you want to fund a particular pool, you’ll need to deposit a fixed ratio of two cryptocurrencies. As a reward, you’d get free tokens and a share of a transaction fee.

All DEXs are self-custodial. Only you are in charge of your wallet and keys. It also requires you to get familiar with the platform and its tools that often are not as user-friendly as CEX.

What makes DEX different from CEX is that you can find everything there. And by everything, I mean even the shittiest of shitcoins. However, decentralized exchanges do not support fiat-crypto trading pairs, so you already have to own some coins. Plus, since centralized exchanges accumulate most of the trading volume, DEXs often struggle with liquidity, so it can be pretty challenging to find buyers or sellers for unpopular cryptocurrencies.

Despite the disadvantages mentioned, DEXs are much safer. As long as you don’t need to submit your keys or private information to a third party, you can be sure that no hacker will compromise your data. Additionally, decentralized exchanges are free from market manipulation due to their peer-to-peer nature. It favorably distinguishes them from CEXs, which are plagued by wash trading used by big players to manipulate market prices.

Finally, DEXs are entirely anonymous. You don’t have to go through any verification procedures or reveal your identity. That also means that no one will be able to track your transactions.

To sum up, choose DEX, if:

  • you value your anonymity
  • you want to trade crypto for crypto
  • you’re a veteran investor
  • you need maximum security

What’s the problem with centralized exchange?

At the beginning of the article, I’ve mentioned that some crypto community members perceive centralized exchanges as not being in line with crypto ideals described in Satoshi Nakamoto’s white paper on Bitcoin. For the pioneers of blockchain technology, who were often people of libertarian and anarchist mindset, cryptocurrency was more of an ideology than finance. They viewed it as an opportunity to take power over money from the government.

Crypto had to spark the revolution in finance, but instead, it was taken over by institutional investors and private whales. They can manipulate the market as they wish, without the fear of consequences from the regulating authority, because there’s none in the crypto world. And centralized exchanges give them this power. At the same time, CEXs can ban anyone from using their services to comply with the demands of central governments, as we witnessed most recently in the case of Russian users. Moreover, CEXs charge fees, own your data and facilitate transactions, which is not very different from the role of traditional finance Bitcoin sought to destroy.

Of course, most crypto investors view it as a speculative asset and not an ideological manifesto. In that context, CEXs do a fair job providing people with tools to trade their money. After all, everyone decides for themselves what they’re looking for in the world of crypto – a community of like-minded individuals, a way to make money, or freedom from the state.

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