Decentralised vs. Centralised Exchanges: Pros and Cons

Time Of Info By TOI Staff   February 6, 2024   Update on : February 6, 2024

Decentralised vs. Centralised Exchanges

The choice between centralized and decentralized exchanges is a pivotal aspect of the cryptocurrency landscape. Centralized exchanges offer convenience and liquidity but come with security and control concerns. In contrast, decentralized exchanges prioritize security and user control but may lack some user-friendly features. 

Understanding the pros and cons is essential for anyone engaging in the dynamic world of digital asset trading.

What is Crypto Exchange and How Does It Work?

A cryptocurrency exchange is an online platform where digital currencies such as Dogecoin, Ether, and Bitcoin may be bought and sold. This operates very similarly to other trading platforms that you may be acquainted with. It gives you access to accounts in which you can make various kinds of orders for buying, selling, and trading cryptocurrency.

Cryptocurrency exchanges function similarly to stock exchanges. Each provides a gateway where users can establish various order types to buy, sell, and trade cryptocurrencies with one another.

The two kinds of crypto exchange are decentralised exchange (DEX) and the centralised exchange (CEX). Find out more about these two crypto exchanges along with their pros and cons in this article. 

Decentralised Exchange Defined

Decentralised Exchanges, or DEXs, are online marketplaces for cryptocurrencies where users can conduct one-on-one transactions. These transactions take place via self-executing agreements known as smart contracts.

DEXs eliminate the requirement of any authority, and the users keep control of the private keys of their wallets. A private key works on an advanced encryption mode that gives users safe access to their assets. Users stay anonymous as they do not submit personal details such as name, address, etc.

The technology underlying a decentralised exchange is blockchain technology. It facilitates transactions that do not require an intermediary- a bank, broker, payment processor, etc. In technical terms, it is a platform whose backend is on top of existing blockchain infrastructure. All transactions are recorded in it for transparency and safety.

Centralised Exchange Defined

Centralized Exchanges (CEX) function similarly to traditional financial institutions, acting as an intermediary between transaction participants. These platforms serve as virtual marketplaces, allowing users to buy, sell, and trade cryptocurrency. CEXs are managed by a centralized entity or organization that oversees and facilitates all activities on their platforms.

Users can transfer fiat currency, such as dollars, directly into cryptocurrency on centralized exchanges, which makes it simple to begin trading cryptocurrencies.

Difference between Centralized and Decentralized Exchanges

First, let’s understand the difference between centralized and decentralized exchanges. A centralized exchange is run by a third party that supervises the trades on an exchange.

On the other hand, a decentralized exchange is not run by anybody. The trades happen via smart contracts.

Centralized exchanges require users to give their personal information for regulatory compliance purposes. Decentralized exchanges do not require one to do so.

Let’s understand the differences between them:

Key Features

Speed and Ease of Use: Centralized exchanges are fast, have an easy user interface, and offer a seamless experience. Though one has to go through the KYC procedures, the trades are instant. Users have the option to use cryptos, online transfers, and cards to buy and exit from the crypto exchange. In this case, the exchange retains the custody of assets.

On the other hand, decentralized exchanges are slow and difficult to navigate. One can only trade pairs on these exchanges, i.e., you can only buy via cryptos. Moreover, trades are not instant and take a few seconds to settle. But users have custody of their crypto assets in their wallets.

Security

Security is a much bigger issue at centralized exchanges than at decentralized exchanges. Hackers are more frequently attacking centralized exchanges due to their architecture. And since a user does not hold custody of the assets, the risk of losing is much higher. DEXs also get hacked, but the hacker can at best get access to the smart contracts of the users and not the whole exchange.

Fees

At the outset, the transaction fees may be higher on a centralized exchange, but that’s not entirely true. On a centralized exchange, you pay fees on the trades and withdrawals. But on a decentralized exchange, you pay gas fees on various steps like transaction approval, trade swap, etc.

Liquidity

CEXs have a much stronger liquidity position and allow large trades for more liquid cryptos. DEXs have lower liquidity due to being on-chain. In the case of large transactions, DEXs generally see slippages at worse prices, resulting in higher prices for traders.

Continue reading to know more about the pros and cons of these two types of crypto exchange.

Decentralised Exchange Pros

Decentralised exchanges have several benefits over centralised ones. Here are all the advantages of decentralized exchange as listed below:

Availability of Coins

DEXs offer a virtually limitless range of tokens, from well-known to random, with different utility cases. CEXs have to verify tokens and conduct due diligence before listing them, unlike in decentralised exchanges, they can list any coin, which means anybody can list their coin on DEXs before listing on CEXs. 

Anonymity

One does not need to do any KYC procedures to trade on a decentralized exchange, which helps maintain anonymity.

Lesser Security Risks

A decentralized exchange allows you to use an external wallet to carry out the trading. Here, the details of your private key are not registered on the exchange’s servers, giving you complete control over your wallet and funds.

Decentralised Exchange Cons

DEX also have a fair share of disadvantages. Here are some of it:

Not User-Friendly

Decentralised exchanges are not easy to operate both in terms of user interface and currency conversion. For example, consumers may not always be able to deposit dollars and swap them for cryptocurrency on decentralized exchanges. This implies that to obtain cryptocurrency for usage on a DEX, you must either already possess it or obtain it through a centralized exchange.

Smart Contract Flaws

Smart contracts are open-source, which means anyone can view them. Moreover, smart contracts of large DEXs are audited by reputable firms. In all possibilities, some bugs can still skip the audits. They may be unable to spot new and complicated bugs that can cause damage to the liquidity providers.

Lack of Robust Features and Functionalities

Unlike their centralized counterparts, most DEXs only facilitate the crypto exchange and lack smart features.

They miss out on several essential features such as margin trading, stop loss, etc. These features are crucial for trading. For this reason, DEXs are yet to gain as much popularity as centralized exchanges.

Unverified Tokens

As the coins listed on decentralized exchanges are not vetted, there is a massive population of coins on DEXs. The scope of scams and rug pull is much higher on DEXs. It’s crucial to conduct proper due diligence before investing in any crypto.

Centralised Exchange Pros

Centralised exchanges have their share of advantages, the reason why many crypto enthusiasts use them. Here are some of it: 

User-Friendly Interface

Centralised exchanges are easy to navigate making it simple for both experienced and inexperienced users to navigate, deposit, and withdraw their crypto money.

Robust Liquidity

Because they have access to a larger pool of buyers, sellers, and regulated market makers, CEX has higher liquidity than DEX. Collateralized debt obligations, options, and futures are examples of asset derivatives that can be traded on certain CEXs; these additional product offerings typically have greater liquidity.

High Regulatory Assurance

Since many centralized cryptocurrency exchanges are operated by licensed businesses, they must adhere to strict regulatory oversight. This is a crucial component that attracts institutional investors who deal with cryptocurrencies and need some level of regulatory compliance. Professional traders and investors find this element appealing as well.

Centralised Exchange Cons

Along with the advantages of centralised exchange, it also has disadvantages. These are: 

Vulnerable to Security Risk

In the course of routine operations, centralised exchanges collect vital and sensitive information. For example, you use a private key to operate your e-wallet for every transaction. The details of your private key get registered and stored on the exchange’s servers which may be vulnerable to hackers.

No Control to Wallet Keys

In CEX, users have no access to their crypto wallet keys. If an unregulated exchange suddenly closes down, for example, they may suffer large losses because they do not have immediate access to their assets.

Tight Regulations

Centralised exchanges are managed by regulated organizations under the watchful eye of regulatory bodies. Regulatory bodies have the authority to enforce rigorous measures, such as new licensing standards and compliance guidelines on the platforms. This may restrict their capacity to support specific tokens or provide services to customers in specific regions.

Final Thoughts

In conclusion, centralized exchanges offer convenience and liquidity but pose security and control risks. On the other hand, decentralized exchanges prioritize security and user control but may lack liquidity and user-friendly features. The choice between them depends on individual preferences, trading goals, and risk tolerance.

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