Decentralized vs Centralized Bitcoin Exchanges – Can They Co-Exist?
One of the most outstanding properties of cryptocurrency lies in its decentralization. It means that the critical decisions are made by all network participants, and not a separate central authority. However, the principles of decentralization, embodied in cryptocurrencies, are not yet implemented by cryptocurrency exchanges to the full extent. Most cryptocurrency trades take place within centralized exchanges, and not within decentralized ones.
Centralized Exchange: The Basics
Centralized cryptocurrency exchanges (CEX) are those exchanges that come to our minds when we think about buying or selling Bitcoin. And this is for a reason. In fact, 90% of exchanges available in the market are centralized. Basically, these are licensed and regulated businesses that provide financial services.
CEX acts as an intermediary between a buyer and a seller that ensures efficiency of the performed trades. It offers a marketplace, where users can buy, sell, or trade cryptocurrency at a specific cost. To perform any activity within a CEX, the user must register, verify their identity, and deposit money.
Centralized exchanges are excellent for beginners who want to enter the world of cryptocurrency, and who need an interface that acts as a bridge between the traditional and cryptocurrency economy. Since their inception, centralized exchanges have provided millions of users with access to Bitcoin, Ethereum and other crypto coins.
Such platforms offer high liquidity as there are many traders using them. This leads to large trading volumes across various cryptocurrency pairs. Examples of CEXes are Binance, Bitfinex, Kraken, CEX.IO, Coinbase, etc.
Decentralized Exchange: The Basics
Decentralized exchanges (DEX) are designed so that there is no third party between the participants to the trade. As a rule, DEX does not match orders on the basis of the exchange order book, instead it directly connects the traders who place buy and sell orders.
Decentralized exchanges provide significant benefits to their users, and the absence of an intermediary results in a low commission per transaction.
DEX ensures greater privacy as it does not require personal data to verify the identity of users who trade on such platforms. Any disclosure of identity may be needed only at the stage of conducting transactions with the peer trader.
Security on decentralized exchanges is greatly enhanced due to the fact that such platforms do not store users’ cryptocurrencies or fiat money. It means that there are no servers that can be hacked.
Despite their advantages, decentralized exchanges are not as famous as centralized platforms. Accordingly, they have fewer customers, lower trading volumes and liquidity since it is more difficult to find a suitable deal at a DEX.
Also, decentralized exchanges have no options like margin trading or automated trading, which makes them less popular among professional traders. Examples of DEXes are Cryptobridge, EtherDelta, Waves DEX, Bisq, etc.
Critical differences between CEX and DEX
DEXes are considered to be more secure than CEXes since there are no central servers that support the platform. They do not store any of the user cryptocurrency or data, which makes them less susceptible to hacking and privacy breaches. Over the past nine years, more than 30 hacks of centralized cryptocurrency exchanges have taken place. Among them the Mt.Gox, Coincheck, and BitGrail hacks are the most outstanding. Theft attempts occur every day, as fraudsters are still searching for ways to exploit centralized system vulnerabilities.
CEXes, on the other hand, have higher liquidity, better functionality, and more diverse marketplaces. Moreover, some of them provide insurance coverage to protect user funds kept within the platform. This is not the case with DEXes as they are mostly based on trust between parties to the deal. These are certainly the features that lure customers away from decentralized exchanges.
Which model is better: CEX or DEX?
It is tough to tell which kind of cryptocurrency exchange is better as they were designed to solve different issues. If simplicity and flexibility of the trading process are essential for you — use centralized exchanges. If you worry about your data privacy and anonymity — trade within decentralized exchanges. In any case, before using a cryptocurrency exchange, read the news and customer reviews about it.
The commission for services is lower on decentralized exchanges. But it is unlikely that a large amount of money can be exchanged right away. Small transactions are more widespread here, because they act as an additional method of protection against fraud.
When it comes to legality, most centralized cryptocurrency exchanges are regulated businesses and comply with the laws of each country they cover. Currently, operations with cryptocurrencies are officially allowed in Australia, Germany, Sweden, Switzerland, the USA, Canada, Japan, Finland, Denmark, Great Britain, Estonia, and Malta. Many countries such as Indonesia, Bolivia and China prohibit the use of cryptocurrency.
Although these two kinds of exchanges differ, it is necessary to note that CEXes and DEXes can co-exist and even complement each other, resulting in so-called “semi-centralized” exchanges. Such exchanges function as CEXes, but they do not store cryptocurrency at online accounts or central servers. Many people believe that most cryptocurrency exchanges will switch to this model soon. Indeed, big cryptocurrency exchanges, such as Binance, have already announced the launch of their own DEXes. Coinsquare has acquired a decentralized cryptocurrency exchange to further optimize its operations.